Inflation and indexation in Iceland
Inflation! – Step one, understanding the problem.
Inflation and Indexation
Inflation in Iceland has been a big problem in the past. 30-50% inflation rate have been a reality in past. But in the last two decades, the inflation has been pretty even, for example between 2000-2012 the inflation rate was 5.9 % at average. In the years between 1970-1980 the inflation rate was so high that the purchasing power of the average home increased so fast that the banks in Iceland were actually losing money by lending it. So the government and the banks decided that the best way to protect the banks is to lend with an inflation indexation, in other words now the banks can’t lose money, regardless of the inflation.
The inflation indexation is calculated monthly on top of the capital of the current loan amount.
Example:
You borrow 100.000 dollars (Iceland equivalent about 12.8 million kronur) for 25 years and your first payment is scheduled to be $335 of the capital plus $335 for interest, the first month based on 4% yearly interest rate, leaving the balance of $99.665. In this example we will use the average inflation rate between 2000-2012, which was 5.9%. That means that the correction (indexation) added to your loan will be $479 leaving you with a total balance of $100.144 after the first month’s payment.
Of course you see that the loan has to be recalculated each month based on the accurate inflation rate and those months that have more inflation your loan amount will actually increase more. Here is a typical illustration of the lifetime of an inflation indexed loan.

source: https://www.landsbankinn.is/einstaklingar/lan-og-fjarmognun/ibudalan/reiknivel/ – loan calculator.