The Icelandic government said Saturday it would write up to 24,000 euros off the mortgage of every household, making good on an election campaign promise despite international warnings over the plan.
The cost of the measure is estimated to reach 150 billion krona (900 million euros, $1.2 billion) over four years, the government said in a statement.
It would be funded by taxes on banks and funds managing assets of banks which went bust during the 2008 financial crisis, added the government.
The Progressive Party -- led by Prime Minister Sigmundur David Gunnlaugsson, winner of late-April elections -- had won voters over with its campaign promise to offer household debt relief.
Gunnlaugsson has said since taking office that the scheme would not hurt public finances, and had initially suggested that foreign creditors of Icelandic banks would bear the write-off.
The debt relief promise has been met with scepticism elsewhere, with both the International Monetary Fund and the Organisation for Economic Cooperation and Development warning against it.
The IMF had previously said that Iceland has "little fiscal space for additional household debt relief", while the OECD had called for the mortgage relief efforts to target only low-income households.
Standard & Poor's also slashed the outlook for Iceland's long-term credit rating to negative from stable, saying the plan could damage foreign investors' confidence if it is to be funded by existing creditors of Iceland's banks.
The agency further warned that it could still lower Iceland's ratings over the plan.
But Finance Minister Bjarni Benediktsson swept aside the criticisms, telling public television Ruv: "We think that there is no doubt in the fact that this tax can be put in place. And if it comes under attack, we will defend it up to the highest jurisdiction."
Many Icelandic households are struggling to repay housing loans indexed to inflation that seemed safe prior to the 2008 financial crisis but has caused borrowing costs to skyrocket following the krona's collapse against other currencies.
"Currently, household debt is equivalent to 108 percent of GDP, which is high by international comparison," said the government in a statement.
"The action will boost household disposable income and encourage savings," it said, adding that the debt relief would begin mid-2014.