I was In Iceland in 2001 and it is possible to get a 4x4 camper for less than that (approx 1200 USD a week incl 1200km) - check
Tel. + 354 564 6000
Fax + 354 564 6001http://www.randburg.com/is/camper/index.asp
We had opted for the two door nissan - two beds - perfect for two. The space behind the two seats was perfect to store camera gear during driving. Here it was safe/dry and perfectly accessible. Prices were approx. 100'000 ISK or 1150 USD for a week and 1200 km. The advantage of the fold up roof is low point of gravity during driving, therefore it is possible to cross rivers and use cat 3 pistes. No toilet but good gas heating. Very basic, but who needs more? We did the same Michael proposed later - eat out at gas stations but we did not take camping gear / tents and slept in the car - very comfy, heated and dry and less stuff to take along (only sleeping bag). I have no experience with the bigger cars.
The guys of J&S are very friendly. We overrun the limited mileage (100km per day) by 500km. A bottle of baileys cut the price per additional mile in half :-) - highly recommended. As for the route we decided (since we only had a week) to stay in the sw - se area (most eastern point was jokull sarlon). We first went to see the geysirs and then cut directly (piste) to landamannaugar and then direct (piste) to join the coastal highway. Those days and nights on these in-country (very bad roads) were phantastic for taking pictures.
Don't expect hotels to be a cheap alternative. The prices are horrendous and there aren't any to begin with (except in the agglomerations). By far the best way (and the cheapest) is to rent a 4x4 camping car that can accomodate 2 people and luggage
For what its worth