Ask An Expert: How Come We Have Inflation-Indexed Loans In Iceland?

If you’ve ever attempted to buy a home in Iceland, you may have noticed inflation-indexed housing loans on offer. If you rent, you may have an agreement with your landlord that your rent may change from month to month because the landlord took out such a loan on the property you’re now renting. Inflation-indexed housing loans are fairly uncommon in Europe, so what makes Iceland so special? We asked Þórir Gunnarsson, an economist at the Icelandic Confederation of Labour, to explain.

“Inflation in Iceland has been great, compared to the general inflation rate in Europe. It’s not too long ago that depositors lost their deposits and credit institutions on loans due to persistently high inflation.

“Credit institutions are now careful not to lose out on loans with indexed loans or spreads due to inflation on non-indexed loans. The inflation premium is added to the interest rate on non-indexed loans and the interest rates are therefore higher here than in a stable price environment. Indexed loans spread the risk of inflation with increasing principal over the loan period, but at the same time lower interest rates that otherwise can be offered.

“The debt service burden of indexed loans is lower in the beginning and the loans are an option for those who enter the real estate market to take out loans that would otherwise be difficult to support. Young people have applied for indexed, 40-year equal-payment loans due to a lower debt service burden in the environment of high interest rates and inflation. Real estate buyers get more expensive housing with indexed loans but pay for it with interest on the principal, which rises with prices over the loan period. Younger people who enter the real estate market with indexed equal-payment loans are then offered to refinance with rising income and have the option of converting to non-indexed loans.”

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