What is an Acceleration Clause?
An Acceleration clause in a contract gives the lender a right to demand full repayment of the unpaid borrowed sum if the borrower has failed to fulfill certain conditions of the contract. You will most likely come across acceleration clauses in mortgage loans and real estate lending.
As such, these provisions protect the interests of lenders by reducing the lending risks.
Acceleration Clause Example
We will now take the help of some examples to explain this concept thoroughly.
- John takes a home loan that has a tenure of ten years. He has been paying the loan dues in instalments. Unfortunately, he fails to pay the instalment in the fifth year.
- The lender of the loan has put an acceleration clause in the lending agreement. It states that the borrower will have to immediately repay the remaining amount if one or more instalment is missed.
- If John is successful in paying the unpaid principal amount of the loan, he will get the ownership of the house.
- But if he fails to make the payment, then it will be considered a breach of contract. As a result, the lender will gain the right to cease John’s property.
- House ceasing comes from the levy, which will also be mentioned in the contract. Levy gives the lender a right to cease the debtor’s property upon failure to pay the debts.
It is important to note that the acceleration clause will not get triggered on its own if you fail to pay an instalment. The trigger happens after the lender decides to invoke the clause.
What Trigger the Acceleration Clause?
Let us list out some of the situations that can push a lender to invoke this provision.
#1 – Inability to Pay Interest Payment
Interest rates are usually charged by the lender on the principal amount. It would be spelt out in the contract that how many missed payments would lead to the acceleration clause’s trigger.
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#2 – Due-on-Sale
You must be aware that in the mortgage loans, the borrower uses a property to mortgage the loan. In other words, the loan is secured against this property. So, if the borrower fails to repay the loan amount, the lender has the right to sell off this property to recover the borrowed sum. But what if the borrower has already sold the mortgaged property?
For such cases, Due-on-Sale comes as a rescue. It is a covenant used in mortgage loans. It helps the lender to demand full repayment of the principal amount of the loan in case the borrower sells off the property with which the loan had been mortgaged.
#3 – Failure to Meet Mortgage Payment
This particular acceleration clause trigger occurs mostly in real estate loans where massive loan sums are involved. Therefore, in such cases, the repayment is usually made in fixed intervals using mortgage payment and interest payment. If any of these payments are not honoured, it triggers the clause.
#4 – Breach of Debt Covenants
Debt covenants are like restrictive covenants imposed by the lender to combine the lender and borrower’s interests. These clauses in the agreement specify specific rules which the borrower must follow. If the borrower does not adhere to the terms specified under this covenant, the lender can demand full repayment of the outstanding loan amount. It will also lead to a breach of covenant.
Acceleration Clause vs Alienation Clause
- Understand that the two provisions are different. It is because, apart from mortgage loans, the Alienation clause is found in insurance and finance contracts.
- This clause pertains to the transfer or sale of a particular asset when the borrowing party fails to fulfill the financial obligation mentioned in the contract.
- This clause acts in favour of the borrowers. If the lender has sold their mortgaged property and utilised the money to recover the outstanding loan amount, it releases the borrowers from future payments.
- Here the borrowers are released from the contract only after the property is transferred to the new owner.
Advantages
Is this clause a boon for lenders? Does it hold any benefit for the borrowers? We will give such insights on this concept by throwing some light on its ups and downs.
- Bad debts are a common occurrence in the lending business. It helps a lender in recovering the borrowed sum in case a borrower fails to make timely payments.
- Therefore, the lender is at a lesser risk of losing the lent money. It is because like we mentioned above, if an acceleration clause is triggered, then it would demand the borrower to repay the loan or sell/mortgage his property to the lender.
- Once the payment is processed, the borrower gets relieved of any future payments before the maturity of the loan.
- Some such clauses provide relief to the borrowers as they state that the clause will be triggered only after two or three instalments are missed.
Disadvantages
- This is usually unfavourable for the borrower as it demands to pay a large sum of money at once, which may be impossible to materialize at short notice.
- The terms and conditions of the acceleration clauses may seem overwhelming to understand. As such, people often take the help of a lawyer to understand the nuisances of the provisions and trigger points.
- When triggered, it makes borrowers prone to losing their property in addition to losing the money they had paid previously.
Key Takeaways
- An Acceleration clause in a contract gives the lender a right to demand full repayment of the unpaid borrowed sum if the borrower has failed to fulfill certain conditions of the contract.
- You will most likely come across acceleration clauses in mortgage loans and real estate lending.
- As such, these provisions protect the interests of lenders by reducing lending risks.
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