An acceleration covenant is a part of a contract that lets a lender require a borrower to pay back a loan right away if certain conditions aren’t fulfilled. It’s also known as an acceleration clause, and it outlines the situations in which the lender can ask for immediate repayment of the loan.
How Does Acceleration Covenant Works?
Some debt securities and swap agreements come with an acceleration covenant. If the borrower breaks any terms—like missing payments or getting a downgrade on their debt—the lender can collect payment and terminate the contract right away.
An acceleration covenant is there to protect lenders who provide financing to businesses. With this covenant, the borrower might need to keep a certain credit rating. This helps safeguard the lender, who can ask for immediate repayment if the borrower’s financial situation worsens.
You’ll also find acceleration covenants in commercial real estate loans. These covenants are crucial for lenders because they reduce the risk of the borrower defaulting. Typically, they kick in when the borrower misses payments, but they can be structured in different ways. An acceleration covenant might give a lender more power to foreclose and take over a property. This can be handy if the lender thinks they can recoup the loan’s value by reselling the property.
Conclusion
Not every acceleration covenant is identical. Some might require the borrower to pay off the entire loan right away if they miss just one payment. Meanwhile, other agreements might be a bit more forgiving when it comes to late payments. Additionally, an acceleration covenant could set rules for selling or transferring the property to someone else.
When a contract is breached and the acceleration covenant kicks in, it frees the borrower from making any more interest payments and mandates that they repay the full loan amount.