What Is an Acceleration Covenant?
An acceleration covenant is a contract provision that allows a lender to demand a borrower to immediately repay a loan if specific requirements are not met. Also referred to as an acceleration clause, the acceleration covenant stipulates under what circumstances the lender can demand immediate loan repayment.
Acceleration Covenant Explained
Some debt securities and swap agreements include an acceleration covenant. If the borrower violates any number of terms—such as missing payments or receiving a downgrade of its 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. Under an acceleration covenant, the borrowing party may be required to maintain a specified credit rating. This requirement helps protect the lender, who can demand immediate repayment if the borrower's finances deteriorate.
Acceleration covenants are also found in commercial real estate loans. The acceleration covenant is important to lenders because it lowers the risk of the borrower defaulting. 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 could give a lender greater ability to foreclose and take possession of a property. This clause may be useful if the lender believes it can recover the loan's value through a resale.
How an Acceleration Covenant Works
Not all acceleration covenants are the same. Some acceleration covenants may demand immediate payoff after the borrower misses a single payment. Other contracts will provide more leniency on delinquent payments. 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.