What is an Acceleration Clause?

What happens when someone who borrows money via a contract can’t pay it back? Unfortunately, the answer can be more complicated than you’d think. The acceleration clause was invented to address and reduce these complications.

Whether you’re borrowing money or loaning it out, it’s important to understand the acceleration clause. As a lender, it protects you from the risk of default and helps ensure you get your money back. As a borrower, it clarifies the nature of your repayment obligations and can even help you reduce the interest you’ll have to pay.

This blog covers key issues borrowers and lenders alike need to know about the acceleration clause, including what it is, when it comes into effect, and why it matters.

This blog post is offered for general information purposes only. It does not constitute, and is not a substitute for, legal advice.

What is the acceleration clause?

An acceleration clause, also known as an acceleration covenant, is a type of clause included in loan contracts. It outlines certain, specific conditions in which the lending party may legally compel the borrower to pay back all outstanding requirements of the loan they took out immediately - before the standard terms of the loan are set to expire.

Acceleration clauses are most common in mortgage loan contracts and some leases.

Why does the acceleration clause matter?

Acceleration clauses exist to protect the lender and minimize the risk of default.

Like other contract clauses, acceleration clauses also specify and simplify what happens if payment conflicts arise. By including an acceleration clause in a loan contract, both the lender and the borrower can end the contract by fulfilling the full repayment. This can save everyone significant time and money, especially if the contract would otherwise need to be contested in court.

When does the acceleration clause come into effect?

Very few acceleration clauses trigger automatically. Instead, it’s typically up to the lender to invoke the clause. The four most common reasons why a lender will invoke the acceleration clause include:

1. Failure to make payments on time: In loans where the principal is very high, such as mortgages, most loan contracts will have the borrower pay back the loan in payments over fixed intervals of time. If the borrower fails to make one or more of these payments on time, the lender may invoke the acceleration clause.

2. Failure to make interest payments: Most loan contracts specify an interest rate that the lender charges the borrower. As the borrower makes payments on their loan, they also have to pay this interest rate. Most acceleration clauses specify a threshold for the amount of missed interest payments before the borrower can invoke the clause.

3. Due-on-sale clauses: A due-on-scale clause is a clause related to acceleration clauses that can be written into loan agreements for property. It specifies that if the borrower sells the property that is still being mortgaged for the loan, the borrower can trigger an acceleration clause to receive their full repayment immediately.

4. Breach of debt covenants: A breach of debt clause or covenant places special rules and restrictions on what the borrower can use the loan for. If the lender breaches these restrictions, the borrower can trigger the acceleration clause for full repayment.

The circumstances in which a loaning party can invoke their acceleration clause vary and will be specified by the individual acceleration clause. For example, while some specify that a lending party can invoke the acceleration clause after the borrower misses even one payment, others might provide the borrower with a grace period or a few chances to pay on time.

What happens when a lender invokes an acceleration clause?

When the lender sends notice that they are invoking the acceleration clause, the party that took the loan will either have to comply with the consequences specified in the clause or argue in court that the contract was not breached. Notably, if the party that took the loan corrects their default (or breach of the loan contract) before the lender invokes the acceleration clause, then the lender may lose their right to invoke the clause.

The exact actions a borrower needs to take when a lender invokes their contract’s acceleration clause may also vary from clause to clause. In most cases, however, the borrower will immediately have to pay the full remaining amount of the loan they took out.

Can a borrower invoke the acceleration clause? 

It depends on the contract. Most loan agreements will allow a borrower to invoke the acceleration clause themselves and pay back their loan in one lump sum. This would allow them to avoid paying interest on the loan over time.

What happens if the borrower can’t repay the full loan amount?

This depends on the nature of the loan itself. In the case of mortgage loans, which are the most common circumstance in which loaners invoke acceleration clauses, the property the borrower is mortgaging would go into foreclosure. In other cases, the lender may sue the borrower for breach of contract. 

When should I include an acceleration clause in my contract?

Include an acceleration clause in a loan contract if you want to reduce risk for the borrower. Your acceleration clause will provide clear instructions on what happens if the borrower breaches the contract and help ensure that the loaner can receive repayment quickly and completely.

Law Insider provides several sample write-ups of acceleration clauses for reference to get the language right.

If you’re interested in adding acceleration clauses to your loan contracts, Docusign can help. Get in touch to find out how.