Oct. 14 (Bloomberg) -- Karl Karlsson, a Reykjavik taxi driver, has canceled his winter vacation. The money he saved is being eaten up by his car loan payment, which has jumped more than 20 percent since June.

Like thousands of Icelanders, Karlsson borrowed in foreign currencies to get a cheaper loan as the benchmark domestic interest rate soared to 15.5 percent this year. With trading in the krona virtually suspended after it plunged against the euro, dollar and yen, debtors now face skyrocketing bills.

``I was told it was better and cheaper to take a loan in foreign currencies than in Icelandic kronur,'' said Karlsson, 65, who now pays 74,000 kronur a month (about $770) on his loan, compared with 59,000 four months ago.

So-called currency basket loans, whose exchange rates are usually adjusted every three months, accounted for 14 percent of household debt in Iceland at the end of June, or 244 billion kronur, according to a Sept. 26 note from the research department of Glitnir Bank hf. Last year the figure was 7 percent.

``If the krona goes down, the principal will go up,'' said Frosti Olafsson, an economist at the Iceland Chamber of Commerce, who added that half of his car loan was in foreign currencies. His monthly payments jumped 30 percent in the past year.

Lenders began promoting foreign currency loans as interest rates and inflation soared amid a four-year economic boom on the volcanic island that's home to 320,000 people. The expansion went bust this month as the credit crunch made it impossible for Icelandic banks to refinance their debt.

The currency has been in freefall since last week, when Iceland put Glitnir, Landsbanki Islands hf and Kaupthing Bank hf, its three biggest lenders, into receivership.

Currency Shunned

On Oct. 8, the central bank, Sedlabanki, abandoned a peg to the euro after just one day when it was unable to defend the rate of 131 kronur per euro. Trading effectively halted when no overseas bank could be found to accept the currency.

Commerzbank AG, Germany's second-biggest bank, said yesterday there is ``no active market'' in the krona. The last quoted price was 340 per euro, compared with 122 a month ago.

A loan of 10 million kronur taken half in Japanese yen and half in Swiss francs in January now stands at 17.8 million kronur, an increase of 78 percent, according to data on the central bank's Web site. That has left people fretting about whether they will be able to keep their cars and homes as the economy deteriorates.

Bank's Tenant

Haraldur Lindal Petursson, the chief executive officer of a local import company, said he's worried about his loan payments as his wife prepares to give birth to their third child.

``It's a Cinderella story but it has its dark side,'' said Petursson, 30, explaining that because of his currency basket loan, his house payment has doubled since June of last year.

Back then, he had paid off about half of his home. Now Petursson reckons he owes more than the house is worth.

With payments eating up 40 percent of his salary, Petursson has postponed a trip to Florida, even though he's already bought the airplane tickets.

``I just live in it,'' Petursson said of his house. ``The bank owns it.''

The government of Iceland has said it may take measures to help citizens with foreign currency loans until the krona stabilizes.

``The government will look into whether we can recommend to the banks that payments on currency-indexed mortgages can be frozen until the currency market is operating more normally,'' Prime Minister Geir Haarde said at an Oct. 9 news conference.

Debt Relief

Glitnir, which started offering such loans in 2004, has instructed branch managers to let customers temporarily pay only the interest rate on those mortgages. The arrangement will end once the krona becomes more stable, spokesman Mar Masson said.

``This has a great effect on every consumer in Iceland, and it is also bad for business as people cannot use the money they are now paying for their more costly loans on something else,'' said Gisli Tryggvason, Iceland's consumer ombudsman, who also has a foreign currency loan.

Sales of new vehicles slumped 30.2 percent from a year earlier in the first nine months of the year, the Umferdarstofa traffic safety agency said on its Web site.

Last week's crisis brought spending on such big-ticket items to a virtual halt.

``The sales of new cars and machines have been reduced dramatically,'' said Birgir Sigurdsson, CEO of Hekla, the country's largest car dealer, whose main showroom in Reykjavik was empty at noon Oct. 9. ``People have stopped spending on more expensive goods -- spending has halted.''

For Karlsson, there's at least some comfort that he has company in his misery.

``A lot of people did the same thing and now they will have problems,'' he said. ``Many will be forced to sell homes and cars.''

To contact the reporters on this story: Niklas Magnusson in Stockholm at nmagnusson1@bloomberg.net; Chad Thomas in Reykjavik, Iceland, via the Helsinki newsroom at cthomas16@bloomberg.net

Last Updated: October 13, 2008 21:03 EDT