What Is an Acceleration Clause?
An acceleration clause is a contract obligation requiring borrowers to pay off their mortgage in full if they don’t meet certain requirements outlined in the mortgage. Many debt instruments contain acceleration clauses, but they are most common in the real estate industry. Since most mortgages involve large sums of money, acceleration clauses protect lenders when borrowers miss payments or break any covenants defined in the mortgage.
It is also known as an “acceleration covenant.”
The exact details and requirements for an acceleration clause will depend on the terms that the parties agreed upon during negotiations. In some cases, the borrower might only be required to make good on any past missed payments. However, in most cases, they will be required to pay the entire remaining amounts, plus interest and other costs (usually only the interest at the current time, not interest on future payments).
In a real estate setting, an acceleration clause in a mortgage loan or other real estate contract can have major effects. In many cases, the borrower cannot afford to pay the entire remaining amount, and this will often lead to a foreclosure on the property.
Acceleration Clause Explained
An acceleration clause allows the lender to require payment before the standard terms of the loan expire. Acceleration clauses are typically contingent on on-time payments.
Acceleration clauses are most common in mortgage loans and help to mitigate the risk of default for the lender. They are usually based on payment delinquencies but they can be structured for other occurrences as well. In most cases, an acceleration clause will require the borrower to immediately pay the full balance owed on the loan if terms have been breached. With full payment of the loan the borrower is relieved of any further interest payments and essentially pays off the loan early at the time the acceleration clause is invoked.
An acceleration clause is usually based on payment delinquency, however the number of delinquent payments can vary. Some acceleration clauses may invoke immediate payoff after one payment is missed while others may allow for two or three missed payments before demanding that the loan be paid in full. Selling or transferring the property to another party can also potentially be a factor associated with an acceleration clause.
For example, assume a borrower with a five year mortgage loan fails to make a payment in the third year. The terms of the loan include an acceleration clause which states the borrower must repay the remaining balance if one payment is missed. The borrower would immediately be contacted by the lender to pay the remaining balance in full. If the borrower pays then they receive the title to the home and takes full ownership of the property. If the borrower cannot pay then they are considered in breach of contract and the lender can foreclose and seize the property for resale.
When Is an Acceleration Clause Triggered?
As mentioned above, the exact terms for an acceleration clause will vary for each individual contract. It is generally up to the parties to agree upon when the clause is put into effect, and when the remaining loan amounts are due. Acceleration clauses usually are not automatically triggered. In other words, the lender usually must inform the borrower of their decision to claim their accelerated payment rights.
An acceleration clause may be triggered due to:
- One missed payment
- Several missed payments
- Failure to obtain homeowner’s insurance, or a failure to keep such insurance payments current
- Breach of any other contract terms
- Property tax issues
- Acceleration clauses are typically triggered by one missed payment. This is especially true in contracts where both parties are coming from a business background.
Acceleration Clause Example
An acceleration clause may stipulate that upon the occurrence of any “event of default” or a continuing event of default, the holder of the mortgage may demand the full unpaid balance of the mortgage, along with any unpaid interest before the maturity date of the mortgage.
The clause may stipulate that the holder must pay all interest accrued, without a demand or notice of acceleration.
Events of acceleration also include filing for bankruptcy or any transfer of the property, whether involuntary or voluntary, securing the deed of trust without written consent from the lender.
Invoking the Acceleration Clause
Acceleration clauses are most commonly found in mortgage and real estate loans. Since these loans tend to be so large, the clause helps protect the lender from the risk of borrower default. A lender may choose to include an acceleration clause to mitigate potential losses and have greater control over the real estate property tied to a mortgage loan. With an acceleration clause, a lender has greater ability to foreclose on the property and take possession of the home. This may be advantageous to the lender if the borrower defaults and the lender believes they can obtain value through a resale.