An acceleration clause is a term in a contract agreement that accords lenders the right to demand full repayment of a loan when certain conditions to the contract are not met. It outlines instances where a lender can demand loan repayment and the amount required for the repayment.
Subjective acceleration clause
A subjective acceleration clause is a term in a contract agreement that allows lenders to demand full repayment of a loan under conditions that are not objectively determined (i.e. when a borrower fails to maintain satisfactory operations).
Acceleration clause in real estate
The acceleration clause is commonly found in the contract for real estate loans and mortgages, usually involving a large sum of money. The clause serves to protect the lender from the risk of the borrower's default.
Lenders include an acceleration clause in their contract to gain greater power over the real estate property financed by mortgage and alleviate potential losses from the loan. It allows them to take possession of the property and recover the loan repayment through a resale if the borrower defaults on the loan.
Triggers for acceleration clause
An acceleration clause is typically invoked when a borrower breaches any terms of the contract. Generally, when lenders activate the acceleration clause, a letter is issued to the borrower, indicating the outstanding amount that is owed.
Several reasons contributing to the enforcement of the acceleration clause could include, but are not limited to the following:
1) Missing mortgage payments
When a borrower misses a specific number of mortgage payments, the lender may enforce the acceleration clause. However, if the borrower can repay the missing payments before the lender intervenes, the acceleration clause will not be enforced.
2) Unauthorised property transfer
If a borrower transfers the property financed by the mortgage without the lender's consent, the lender has the power to enforce the acceleration clause. This could be a transfer to a person or a business.
3) Borrower's bankruptcy
When a borrower files for bankruptcy, it implies that he is incapable of repaying the loan. Therefore, the lender can enforce the acceleration clause to secure his loan repayment.
4) Due-on-sale clause
A deal-on-sale clause or alienation clause, is similar to an acceleration clause. It allows the lender to request for full repayment of the principal from the borrower if the borrower sells the property mortgaged by the loan. Therefore, the due-on-sale clause, in a way, triggers the acceleration clause when a mortgaged property is sold.
5) Breach of debt covenants
Suppose a borrower breaches any restrictions imposed by the lender on the loan agreement. The lender can activate the acceleration clause and demand full repayment of the remaining loan payment from the borrower. The lender usually sets the debt covenants to align the interests of both the lender and borrower. In addition, it restricts certain actions of the borrower which puts the lender at risk.
Example of an acceleration clause
Suppose a borrower with a 10-year mortgage loan fails to make a payment in the fifth year. The acceleration clause in the contract stipulates that failure in making any payment of the loan requires the borrower to repay the remaining balance of the loan. As a result, the borrower had failed to meet the contract obligations. If he is unable to pay the outstanding repayment, the lender is authorised to foreclose the mortgage and seize the property for resale to recover his payments.
Acceleration clause versus demand clause
A demand clause is a contract provision that gives the lender the right to demand full repayment of a loan at any time and for any reason.
The acceleration clause works similarly to a demand clause such that both clauses demand full, immediate repayment of a loan from the borrower. However, the acceleration clause differs from the demand clause in terms of the triggers. For an acceleration clause to be activated, the borrower must materially breach the loan agreement. In contrast, the demand clause may be enforced with any reason provided by the lender.
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Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.