What Is an Acceleration Clause?
An acceleration clause is a contract provision that allows a lender to require a borrower to repay all of an outstanding loan if certain requirements are not met. An acceleration clause outlines the reasons that the lender can demand loan repayment and the repayment required.
It is also known as an “acceleration covenant.”
Key Takeaways
- An acceleration clause or covenant is a contract provision that allows a lender to require a borrower to repay all of an outstanding loan if specific requirements are not met.
- The acceleration clause clearly outlines the reasons that the lender can demand loan repayment and the repayment required, such as maintaining a certain credit rating.
- An acceleration clause helps to protect lenders who extend financing to businesses in need of capital.
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.
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.