A clause in real estate refers to a particular section of a contract in either a purchase agreement or lease agreement.
For your real estate exam, there are four main clauses that you need to understand, which impacts mortgage financing.
- Acceleration clause
- Due on sale clause
- Prepayment penalty clause
- And Release clause
An acceleration clause is a condition in a loan contract that allows the lender to ‘accelerate’ the repayment of a loan in the event that specific conditions are not met. These conditions could be missed mortgage payments, a bankruptcy filing, an unauthorized property transfer, cancelled homeowners’ insurance, and not keeping the property in a liveable condition.
A due on sale clause requires that a borrower pay off the entirety of their loan when they sell or transfer the title. This must happen before the new owner can take ownership. This is a standard clause in most mortgage agreements.
A prepayment penalty clause is a condition that states that a penalty payment will be charged to a borrower who entirely or significantly prepays down their mortgage early in the loan term, usually within the first five years. The purpose of a prepayment penalty clause is to protect a lender from loss of interest income. This clause must be clearly disclosed to borrowers at the time of closing.
The last clause you need to know is a release clause. A release clause is a term in a loan contract that releases a creditor from a portion of a collateral claim on real property, usually after a significant portion of the loan balance has been paid. This gives the mortgagor or homeowner full rights to the property and effectively changes the remainder of the loan to an unsecured loan. When this happens, the lender loses priority position (also known as first position) and would have to go through standard collection proceedings in the event of a failure to pay, as opposed to a foreclosure proceeding.
It’s important that real estate professionals clearly understand the clauses in their loan and purchase contracts so that they can better act for and inform their clients.