What is the Acceleration Clause?
Acceleration clause are term and condition involved in lending agreement which allows a lender to make borrower repay entire loan balance and it gets activated on the nonfulfillment of conditions like on-time payments and payment negligence. These clauses are common in loans of mortgage and help in reducing the risk of a lender.
Acceleration Clause Example
- A borrower takes a home loan having tenure of ten years and unfortunately fails to honor payment in the fifth year. Lender of loan puts an acceleration clause in the loan agreement which states that the borrower has to repay the remaining balance immediately if even one or more installment is missed.
- If the borrower is successful in paying the full amount to the lender, he gets the ownership of the house but if he fails to honor payment, then it is considered a breach of contract, and the lender gains the right to cease the property of the borrower.
Trigger for Acceleration Clause
#1 – Inability to Pay Interest Payment
Interest rates are charged by the lender on a borrower. These interest rates determine the amount of interest payment the borrower needs to pay to the lender. If the borrower fails to make any interest payment, it could lead to the triggering of an acceleration clause. The levy provided for the number of missed installments to trigger this clause is mentioned in the loan agreement.
#2 – Due-on-Sale
This clause is a provision made in the loan agreement, which helps the lender to demand full payment of the principal loan amount if any time the borrower sells the property that is meant to mortgage for the loan. That is this clause can be triggered if the property which could be sold on the failure of payment is already sold by the borrower.
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#3 – Failure to Meet Mortgage Payment
These are typically included where the loan amount is higher such as mortgage loans or real estate loans. Repayment is done in the form of interest payment and mortgages payment and at a fixed time interval. If any of these payments are not honored, it triggers the clause.
#4 – Breach of Debt Covenants
Debt covenants are the agreements of restrictions imposed by the lender in order to combine the interest of the lender and borrower. This agreement limits the borrower and helps the lender in setting certain rules on which the borrower must act. The lender can trigger an accelerator clause and ask for full repayment once the borrower breaches these restrictions.
Acceleration Clause vs Alienation Clause
- Alienation clause is a provision generally found in insurance and finance contracts. This clause transfers or sells a particular asset as the party fails to fulfill the financial obligation. It is a basic standard that is usually implemented in every mortgage industry. With the aid of this clause, buyers can’t take over an existing mortgage property.
- This clause basically releases borrowers from their obligations towards lender as the proceeds from the selling of house property will be used in repaying mortgage balance. Here borrowers are released from the lender only once the property is transferred to the new owner.
- Whereas in an acceleration clause if any installment is not paid before the maturity of the loan, the lender can mortgage the property or take ownership of the property in his own hands.
- It helps in protecting the lender in need of capital to extend their business.
- This makes borrowers repay all the outstanding loan if he/she does not meet the specific requirements.
- The lender is not at the risk of losing money if the acceleration clause is triggered as this clause makes the borrower repay the loan or sell/mortgage his property to the lender.
- If any term is breached at the borrower’s side, he is obliged to immediately pay the full balance owed to the lender.
- Once the payment is processed by the borrower to the lender, he/she gets relieved of any interest payments and also full loan is paid off before its maturity.
- Some acceleration clause provides relief to the borrowers as the state clause will be triggered only if two or three installments are missed.
- Since the mortgage and real estate loans are large-sized loans, the lender remains risk-free from the borrower’s default due to this clause.
- The lender of the loan has full control over real estate property connected with the mortgage loan.
- This is usually unfavorable for the borrower as it demands to pay a large sum of money at once which he may be impossible to pay.
- The terms and conditions of the acceleration clause should be thoroughly reviewed and understood by the lawyer as these may be of different nature and have different trigger points depending on what terms were agreed upon while taking a loan.
- Since the clause triggers are unaffordable, borrowers are at risk to foreclose their property and losing the money they have previously paid.
- This clause forces borrowers to seek a new loan to repay the original lender which puts a borrower in a debt trap situation.
- This is a safety clause inserted in every loan agreement that safeguards the interest of lenders against the risk of borrower’s defaults. It is easily avoidable for the borrower if understood properly.
- One must avoid breaching the terms of the agreement in order to keep the acceleration clause untriggered. Although the clause is the right provision for the lender to keep himself risk-free from defaults of borrower side. A lawyer must be consulted to comprehend the terms and conditions regarding real estate loans.
This has been a guide to What is Acceleration Clause & its Definition. Here we discuss the triggers of the acceleration clause and example along with advantages and disadvantages. You can learn more about from the following articles –