When buying or selling a home, real estate contracts include specific clauses or designated sections in purchase or financing agreements that dictate the terms of the transaction. While many sections are standard, four primary clauses have a direct impact on mortgage financing. These are the acceleration clause, the due-on-sale clause, the prepayment penalty clause, and the release clause.
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The Acceleration Clause
An acceleration clause is typically found in a trust deed or mortgage. It specifies that the total debt amount is due immediately in cases when the borrower breaks or defaults on the terms specified in their contract. This enables mortgage lenders to insist upon the complete repayment of a loan when the borrower fails to make a certain number of payments if the borrower wants to avoid foreclosure.
Unmet conditions in a contract that may trigger this clause can also include a borrower filing for bankruptcy, canceled homeowners’ insurance, the property falling out of livable condition, and an unauthorized transfer of the property.
The Due-on-Sale Clause
The due-on-sale clause stipulates that any balance on a residential mortgage loan must be paid by the borrower before the property can be sold or the title transferred. This type of clause is utilized by lenders in order to prevent property buyers from keeping the interest rate of the seller’s loan.
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Due-on-sale clauses are often included in contracts when interest rates are on the rise. Banks enforce this type of clause when they stand to make more money from the buyer obtaining a new loan with a higher interest rate. Loans that include this clause are typically not assumable. This clause is very common and found in most conventional home loan contracts, requiring sellers to pay off the balance of their previous loan in order for the new owner to claim ownership of the property.
The Prepayment Penalty Clause
A prepayment penalty clause in a real estate contract is a penalty fee charged to a borrower who pays off their loan early either in its entirety or pays down a large portion of the mortgage, most commonly within the first five years of the loan. Paying off the mortgage early causes the lender to lose the income they would have made from interest on the loan had it been paid over time.
The fee from this clause compensates the lender with the interest amount they lost with early payment and is calculated as a percentage of the remaining loan balance. This type of clause must be disclosed to borrowers when they are closing on the property.
The Release Clause
A release clause is a stipulation on a loan that allows for the removal of any liens on a property that is part of a blanket mortgage. A blanket mortgage allows developers, builders, and investors the ability to group multiple residences under one mortgage. Once the percentage of the blanket mortgage proportional to the designated property is paid off, the property can then be freed of any liens by the lender, giving the borrower complete rights to the property.
The lender can enact this clause to release a debtor from a claim or collateral on a piece of property. After a release clause is enacted, the mortgage borrower retains complete ownership of the property, and the loan is still collateralized by the remainder of the property in the portfolio. This mechanism is distinct from the other three clauses because it does not change the debt owed by the borrower but rather modifies the collateral securing that debt. While standard home purchases rarely involve blanket mortgages, investors utilizing this financing strategy must be aware that paying off a single property within the portfolio does not extinguish the entire loan obligation.
