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 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 installments. Unfortunately, he fails to pay the installment in the fifth year.The loan lender has put an acceleration clause in the lending agreement. It states that the borrower will have to repay the remaining amount immediately if one or more installment is missed. If John successfully pays the unpaid principal amount of the loanPrincipal Amount Of The LoanLoan Principal Amount refers to the amount which is actually given as the loan from the lender of the money to its borrower and it is the amount on which the interest is charged by the lender of the money from the borrower for the use of its money.read more, he will get ownership of the house.But if he fails to make the payment, 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 levyLevyA levy is a lawful process where the debtor’s property is seized when the debtor cannot pay the outstanding debts. It is different from liens, as a lien is only a claim against a property, whereas a levy is an actual property takeover to fulfill the obligation.read more, which the contract will also mention. Levy gives the lender a right to cease the debtor’s property upon failure to pay the debtsDebtsDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more.

It is important to note that the acceleration clause will not get triggered on its own if you fail to pay an installment. The trigger happens after the lender decides to invoke the clause.

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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

The lender on the principal amount usually charges interest rates. The contract would spell out how many missed payments would trigger the acceleration clause.

#2 – Due-on-Sale

You must be aware that the borrower uses a property to mortgage the loan in mortgage loans. In other words, the loan is securedLoan Is SecuredSecured loans refer to the type of loans approved and received against a guarantee or collateral. If they fail to do so, the lending institution acquires the collateral to compensate for the amount that the borrowers were allowed.read more 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 demand full repayment of the principal amount of the loan if 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, the repayment is usually made in fixed intervals using mortgage payment and interest payment in such cases. If any of these payments are not honored, it triggers the clause.

#4 – Breach of Debt Covenants

Debt covenantsDebt CovenantsDebt covenants are formal agreements between different parties like creditors, suppliers, vendors, shareholders, investors, and a company, establishing limits for financial ratios such as leverage ratios, working capital ratios, and dividend payout ratios, which a debtor must refrain from breaching.read more are 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,Covenant,Covenant refers to the borrower’s promise to the lender, quoted on a formal debt agreement stating the former’s obligations and limitations. It is a standard clause of the bond contracts and loan agreements.read more the lender can fully repay 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. 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 favor of the borrowers. If the lender has sold their mortgaged property and utilized it 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 highlighting its ups and downs.

  • Bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation.read more are a common occurrence in the lending business. It helps a lender recover the borrowed sum if a borrower fails to make timely payments.Therefore, the lender is at a lesser risk of losing the lent money. As we mentioned above, if an acceleration clause is triggered, 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 loan’s maturity.Some such clauses provide relief to the borrowers as they state that the clause will be triggered after two or three installments are missed.

Disadvantages

  • This is usually unfavorable 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.

This has been a guide to What is Acceleration Clause & its Definition. Here we discuss the triggers of the acceleration clause and examples along with advantages and disadvantages. You can learn more about from the following articles –

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