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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. 

25 year loan indexed

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

Your capital will not go under $100.000 until after about 15 years, based on the inflation rate and interest used in this example (very realistic numbers used based on the past). Your payments go up each month during the lifespan of the loan. First payment $670 and your last payment in 25 years from now would be $1.402 (if we can assume that the average inflation rate will stay steady throughout the time period). You’re total re-payments are around $309.500 for the 25 year loan.

The indexation is helping the banks but not the people, it is happening all the time that people can’t pay their mortgage any more and therefore lose their house. Those people have to find a place to rent and the owners of those houses are struggling with the indexed loans themselves so they have the renters pay indexed rent (adjusted to inflation). Now you (the reader) can see how this has a snowball effect on the economy.

Currently there are very few homes that are good investments in Iceland, but somehow the industrial market has not been affected as much as private properties, I assume it’s because professional investors are buying those properties, but I could be wrong.

Example:

Good investment should be a $100.000 property, that you can rent for about $1.000 per month.

$100.000 apartment in Iceland can return about $600-800 rent per month depending on location.

$100.000 industrial property can return about $900-1.100 rent per month, depending on location.


Pension funds in Iceland

Pension funds in Iceland!

Step two, what’s wrong now and how can we fix it.

The pension funds in Iceland are mandatory for working class people to pay 12% of what they earn into a pension fund. Iceland has a few pension funds available and you can choose which fund you join, but it is mandatory to be a part of one. A Pension fund is a fund that is supposed to insure the aging population a safe future after retiring, anywhere from 63-70 years of age.

How are pension funds in Iceland working against the economy?

Pension funds have been having a hard time to find investments with a good return, especially after the government put on capital control on currency flowing from Iceland. One example of a pension fund working against the current economy is a pension fund in Iceland (unnamed here) with a lot of money to invest and not thinking about the future but only the current return on investment. The pension fund decided to buy up property in the Capital (Reykjavik), this might smell to you, a little bit like Enron but I might be wrong. When buying property in large quantity in a small nation, it impacts the economy with false return on their investments like Enron repeatedly did back in the day.

They created a demand in the market by having the property sit empty and unused and therefore increasing the price of property. What they are doing, is creating profits for the pension fund with bullying the market, this has an effect on the current economy and more families don’t have the means to buy their own home and therefore have to rent. That creates a demand for rentals and therefore the already rich, can buy the properties available and rent them out with inflation indexed rent, yes you heard right. Inflation indexed rent means that it will increase with inflation each month, leaving the renter with an unknown cash flow the following month.

Because the funds have an impact on the property prices, the loan capital amounts are higher (inflation indexed loans) and therefore the rent goes up. More and more people have to start renting smaller units and/or moving away from their current work area for a  chance of cheaper rent and commuting to work.

In my opinion the pension funds who do stuff like that are not serving their true purpose.

The cure…… coming soon, keep your eyes open.


Government Loans and Property Management

Government Lending / Mortgages / Bankruptcy / Property Management

ILS – The Housing Financing Fund.

Íbúðalánasjóður (ILS) is a government funded lending institute also known as The Housing Financing Fund (ILS). After the big financial crash in 2008 many families have had to leave their properties because the mortgage on their properties are inflation indexed. After the crash 2008 we saw such an inflation increase that in less than 2 years many families saw their mortgages increase around 50% leaving their property up-side-down (up-side-down is referring to when a property cannot be sold for more that the mortgage current value).

The government then tried to step in and put a temporary new law/solution in play. Many families could no longer pay their mortgage payments, so this law was a temporary solution for families to be able to freeze their mortgage payments for a certain time period, usually around 3-5 years,  this is to give the family a change to get better jobs or somehow have more money available at the end of the allowed time frame. This was of course just a way to postpone what was inevitable.

Two to three years after the crash, the government changed the law regarding bankruptcy as well, from a 5 year probation down to a 2 year probation, giving people a change to file bankruptcy and starting over, giving them a chance to start buying again in two years from bankruptcy. By declaring bankruptcy you move the responsibility (mortgage payments) of their hands and onto the unfortunate persons that signed as a guarantor originally, usually family or friends.

I know this will be hard to believe, but in Iceland debts are rarely lost to banks or housing funds, because we allow mortgage with collateral in peoples personal social security numbers, not just the property itself. That means if a person can no longer pay the mortgage payment he/she is evicted by the bank or ILS. Then the property is auctioned off and what ever remains from the difference of the auction price and the mortgage is still owed by the former owner of that property. Yes this is true! The only solution for that person to declare themselves bankrupt, but that does not solve the problem, only for that person, because then the guarantor of the mortgage becomes the new happy owner of the old mortgage without any property. He/she (the guarantor) is now responsible to pay back the mortgage which, by the way, is still being indexed every month and keeps growing (depending on how many payment are left of the mortgage, see “Inflation and indexation in Iceland” for more details on mortgage growth).

Why are we seeing the banks and ILS repossessing so many properties and holding on to them and not selling them right away?

It is because of the mortgage inflation indexation. The foreclosed properties are now being sold on open market for more that they are actually worth and therefore they are not being bought.

How is ILS solve this this issue of holding on to property?

ILS founded a new corporation (LLC), Klettur ehf. (560508-0690) in the year 2008. This company is 100% owned by ILS. Klettur is run by non affiliated members according to ILS. Klettur ehf, currently has 450 properties to manage and rent out, these properties used to be owned by ILS but were transfered into Klettur ehf, 35% booked as capital startup and 65% of the value lent to Klettur ehf at normal mortgage rates ( inflation indexed).

This is the statement made by ILS in it’s yearly report:

Lögbundinn tilgangur sjóðsins er að stuðla að því með lánveitingum og skipulagi húsnæðismála að landsmenn geti búið við öryggi og jafnrétti í húsnæðismálum og að fjármunum verði sérstaklega varið til þess að auka möguleika fólks til að eignast og leigja húsnæði á viðráðanlegum kjörum.

Translation: Legal purpose of ILS is to ensure, by providing mortgages and property management, that all Icelander’s can live in a safe environment (financial safety) and equality regarding housing and that the funds financial power will be used to increase the possibilities for families to own or rent properties at affordable prices.

I will not go into specific cases here, but I have heard and know of many situations were renters have been forced to move else, after ILS took over management (after foreclosure on the property).  The rent has been almost doubled in some cases within one year after the ILS new property management took over the property.