What Is an Acceleration Covenant?
An acceleration covenant also referred to as an acceleration clause, is a contract provision which allows a lender to require a borrower to repay all of an outstanding loan if specific requirements are not met. The acceleration covenant outlines the reasons that the lender can demand loan repayment and the repayment required.
Acceleration Covenant Explained
Some debt securities and swap agreements include a clause known as an acceleration covenant. It states that if the borrower violates any number of terms, such as default or downgrade of debt, the collection of payment and termination of contract will take place immediately.
An acceleration covenant helps to protect lenders who extend financing to businesses in need of capital. Under an acceleration covenant, the borrowing party must maintain a specified credit rating. This credit requirement helps protect the lender, who can demand immediate repayment if the borrower’s finances deteriorate and might cause the borrower to file for bankruptcy.
Acceleration covenants are also commonly found in mortgage and commercial real estate loans. Real estate loans often include an acceleration covenant to help protect the lender. The acceleration covenant is important to lenders because it lowers the lender’s risk of the borrower defaulting on a significant loan amount. The agreements usually come into play when the borrower fails to make payments, but it is possible to structure them in other ways. An acceleration covenant gives a lender greater ability to foreclose on a property and take possession of the real estate property. This clause may be useful to the lender if the borrower defaults and the lender believes they can obtain value through a resale.
How an Acceleration Covenant Works
Not all acceleration covenants are the same. For instance, payment delinquency is usually the trigger that invokes an acceleration covenant. Depending on the language of the agreement, the clause may not happen after only one delinquent payment. Some acceleration covenants may demand immediate payoff in full after the borrow misses just one payment. Others may allow for several missed payments before demanding the full repayment. An acceleration covenant may also include parameters for selling or transferring the property to another party.
After a contract breach, when the acceleration covenant goes into effect, the clause relieves the borrower of any further interest payments and requires the borrower to pay back the loan in its entirety.