Ísafjörður is the biggest settlement in the West Fjords and gained municipal status on the 28th of January 1866. It is the only market town for the area.

The town is built on a spit reaching most of the way across Skutulsförður inside, which is an excellent harbor. In the oldest part of town, Neðsti-Kaupstaður, there are four of the oldest houses in Iceland, one of which houses the maritime museum.

They were built in the mid-18th century. Fishing has been the main industry for centuries and trade has always been significant. Site of the old parsonage Eyri made famous because of Píslarsaga síra Jóns Magnússonar (the Sufferings of Rev. Jón Magnússon).

The community of skutulsfjörður used to be called Eyrarhreppur from the old parsonage Eyri. Landnámabók (The Book of Settlements) tells of two settlers in Skutulsfjörður, Helgi Hróflsson, who built his farm at Eyri and Þórólfur brækir, who settled in Skálavík.  Helgi is said to have found a harpoon washed up on the beach and named the fjord for it.
In 1786 a royal decree abolished the trade monopoly in Iceland, and six trading centers were established, Ísafjörður being one. In the spring of 1788 Norwegian merchants came to Ísafjörður, which is what the new trading centre was named, settled just below the parsonage at Eyri and built their stores there. 

One of these buildings is still there, Aðalstræti 42 in the area known as Hæstikaupstaður (The highest trading place).

In 1816 Ísafjörður lost its trading centre status but trade continued and there was a lot of growth around the mid-century. Ísafjörðu again became a legal trading centre by royal decree in 1866.

The basis for Ísafjörður's prosperity was the fishing on so-called Þilskip (boats with decks) in stead of the open rowing boats that were still common at the time.  Merchants owned and operated the fishing boats which fished for both cod and shark.

From about 1900-1930 there was also a good deal of herring fishing. There was a steady increase in population, reaching 1,085 by 1901. One of the lagest companies in Iceland at the time, Ásgersverslun, operated in Ísafjörður. The company was by far the biggest producer of the country's most valuable export product, salt fish.

In 1996 the town of Ísafjörður was amalgamated with the villages of Suðureyri, Þingeyri and Flateyri to form ísafjarðarbær (Ísafjörður municipality).