Mermaid Island is a fabled and largely unknown island, which is located some distance away from the coast of Dreamland, and is very close to Walrus Island. As the name would suggest, it is allegedly inhabited by mermaids. Sailors from Dreamland can access this island by party barge.
Not much history is given about this island, other than that it was founded by and named after the human explorer Gerald K. Mermaid.
Princess Bean tricked her fiance Prince Merkimer into sailing on a party barge to this island in hopes of getting rid of him and canceling their wedding, however things became complicated when they ended up accidentally sailing to Walrus Island instead.
It's strongly implied that Elfo's corpse washed up on Mermaid Island, as two female figures (likely mermaids) grabbed him. It's likely to be play a larger role in the beginning of Season 2.