anyway you mentioned a and b as reasons for housing bubble. Actually the housing bubble started with banks entering real estate market.
As for the rest it was the wide spread and the only schema to repay a loan. Namely you had to pay only some ridiculous amount per month which was raising very gradually as the installment was rising due to the indexation. As it was pointed out many times with regard to icelandic CPI indexation of loans, under that schema a regular person was never able to reduce the installment unless after some 10-15 or even 25 years when monthly payment would finally rise to some amount capable of covering the indexation.
Now ask how many peoples are going to divert from the schema proposed by lender by their own will? And if they would then you are probably asking for a trouble. That would mean people do not trust the financial institution of a state. It is not surprising that some foreigners capable analyzing Icelandic situation diverted from the schema. After all very few of them think they are going to stay in Iceland forever and therefor they tried to get away from Icelandic slave-like loans as soon as possible. For an ordinary Icelander the way they live, smile and pay is just a matter of fact. C’est la vie
Now some Icelandic people are rightfully asking good questions what the hell is going on. Why they live in a financial system which by default does not allow them to pay off credit.
The fact is that Icelandic krona was never something of stable value. The indexation tried to put at least some stability in the system but it did not solve the higher than elsewhere CPI. The uncontrolled CPI, as well as uncontrolled bank system growth we witnessed recently, is largely the responsibility of Icelandic Central Bank. Despite the bank building looking cool the institution did nothing over the years. The fact it employed a former drama writer David Odsson as a chairman is just ok because this institution was a right place for people like he. It was doing just nothing anyway.
If you look more closely then Icelandic government was always a funny place. The rumours of Cod War about drunken Icelandic PM asking american NATO commander to attack British speak for themselfs.
Only this time some kind of(kind of!) ordinary Dutch and English savers were affected hence the whole issue with Icesave. I bet Gordon Browns grandma in law lost some value there.

From what I’ve read, the key contributors to the Icelandic housing bubble were (a) high central bank rates , leading to carry trade and therefore excess supply of credit and (b) the market-leading Housing fund maintaining below-market rates, leading to excess demand for credit.

for a long time annuitet loans were the only loans available. Of course you were allowed to make payments in advance but I was not even sure how those payments affected the principal ammount.
Anyway majority accepted the basic payment scheme offered by then the only lender – the housing fund. Then banks came into arena but for a long time the offered annuited, i.e. equal monthly payments. Folks got used to it and stayed happy. Later on a “normal” schema was made available meaning one had to pay much more at the beginning but the payments would decrease with time.
If my mind serves me right this method ment about twice as higher starting payments as annuitet.
Now comes the tricky part – who in his clear mind would choose to pay say 1000 euros instead of only 500 per month for the same house? Add the hefty Icelandic prices on commodity goods and you’ll see that Icelanders were in fact unable to sustain other payments than annuitet. Or real estate prices had to go down. But the housing fund and then banks maintained loans repayment schema which favoured higher than normal house prices.

I should have written that I borrowed ISK 100 on 01.01.2001, and all the opening balances need to be advanced by one year to make sense.

I suspect that this is where the problem is. It seems unlikely to me that the indexation increase *is* paid as it falls due. Far more likely is that it’s added onto the lump remaining and that amount (plus expected interest) is divided by the remaining term to give a smoothed payment.

As you say, in Iceland the effective interest rate can *never* be fixed. Sure, the headline interest component can be fixed at ~5%. But the there will always be a variable indexation amount added.

If it was fixed though, it would be fixed at the average of Mike’s figures (15% over that period) with an additional premium for risk. Fixed rates are a gamble and the banks are the house. Sure, they might lose in a particular case, but they’ll win more often than they lose. So, on average, people would be better off going for varaible rates. Of course, everyone won’t be average, so people often choose to insure against risk by paying that little bit more for a fixed rate. Given Iceland’s volatility, I would expect that premium to be much higher than in other countries.

Anyway, back to the original point. Say I borrowed ISK 100 in 2000. At 5%. Doing rough calcs, and on a 25 year repayment basis:

(100) Opening balance 01.01.2000
(5) Interest for 2001
7 My payments in 2001 (interest plus a part of the principal)
(9) Indexation (@9%, per Statistics.is)
—–
(107) Opening balance 01.01.2001
(5) Interest 2002
8 My payments for 2002
(2) Indexation @2%
—-
(106) Opening balance 01.01.2002

Having done that calc, it seems likely that an allowance for indexation is added to the balance at the beginning of the year and then corrected when the real figures are released. But, even then, if the indexation is higher than expected (and given that the Central bank consistently missed its inflation targets, that seems likely), it’s possible for the loan to grow consistently.

It’s important to note that this outcome is not remarkably different if Mike’s figures are instead used (bearing in mind that the repayments above should have been inflated by the expected indexation to, say, 14 in 2001 and 10 in 2002). Indexation does seem to likely to end-load a lot of the payments, especially as it’s generally human nature to not overpay loans in the early years.

(100) Opening balance 01.01.2000
(17) Interest @17%
17 Repayments
—-
(100) Opening balance 01.01.2001
(14) Interest @14%
15 Repayments
—-
(99) Opening balance 01.01.2002

If you want to play around with it yourself, the indexation rates from 2001 are roughly: 9%/2%/3%/4%/4%/7%/6%/16%/9%
(Actually, those are calculated Jan – Jan, rather than Dec – Dec, but it should be pretty similar).

Bottom line is that, for whatever reason, it seems that people don’t pay off all of the indexation in the year that it is incurred. This is effectively the same as only paying 12% of a 17% mortgage – the amount owed increases.

The indexation increase is paid along with everything else.

In super basic terms; you know those calculations you get with a fixed rate mortgage that show you how much you will pay in, say, June 2017?
Those don’t apply here.
What am I missing?

(seriously, not being a jerk, trying to understand)

It’s quite possible that I’m missing something obvious, but Icelandic inflation is far higher than that in the US & Norway. So if the average mortgage rate in the US/UK, for example, has been 4-7%, and if the average unindexed rate in Iceland would have been 15%, then you’d still have suffered compared to people in the US/UK. I assume it’d be a similar story comparing to Norway.

That 50% increase presumably wasn’t just in the past year, so I assume that you are referring largely to indexation that occurred pre-kreppa.

If the principal has increased, then that’s because people were only paying the annual interest and repayment elements and not the annual indexation increase.

As I said, maybe I’m missing something though.