Types of Clauses


The term "clause" identifies a particular section of a contract. Real estate contracts use many types of clauses that you could see on your real estate exam. So let me go into a little bit of depth about different types of clauses.

Let's start with an Acceleration clause

An acceleration clause in a mortgage or trust deed stipulates that the entire debt is due immediately, if the borrower defaults under the terms of the contract. It will also give the conditions for when a lender can demand a full loan repayment. For example, home loans typically have an acceleration clause that is triggered when the borrower misses too many payments.

Accelerating a loan is usually a bad thing. Usually it means that a borrower has missed payments or violated the terms of the contract and the lender is demanding immediate payment of the full loan amount to avoid foreclosure.

While acceleration clauses are mostly used in commercial and residential real estate, they do appear in some leases too. 

The next clause I want to discuss is the Due-On-Sale clause

A due-on-sale clause, also known as an alienation clause, is a loan stipulation that requires a borrower to pay the entire loan balance if the property is being sold. Lenders use due-on-sale clauses to prevent the buyer of a property from assuming the current loan at the original interest rate.

They are often used in a rising interest rate environment. If a bank feels it can make more money on a loan by requiring the buyer of the property to obtain a new loan with a higher interest rate, it will sometimes enforce the due-on-sale clause. For this reason, most loan with a due-on-sale clause are not assumable.

In short, this is common clause and is found in most conventional home loan paperwork and means that, when a property is sold, the entire balance of the loan comes due. Yup, you have to pay off the whole thing! 

Next we have the Prepayment Penalty clause

Prepayment penalties exist to protect lenders against the loss of interest income that would have been paid on the loan over time. A prepayment penalty clause stipulates a penalty charge which can be imposed on a borrower who pays off a loan early. The fee goes towards compensating the lender for interest and other charges that  would otherwise be lost due to early payment. The prepayment penalty is based on a percentage of the loan balance.

Subordination clause

In real estate, subordination refers to the order of liens on a property. Usually, liens have chronological priority- the first lien to be recorded is first to get paid, etc. To adjust the priority of a lien, a lender may require a subordination clause. A subordination clause effectively makes the current claim senior to any existing claims that have already been recorded.  

Subordination clauses are typically used when a home loan is refinanced and there are existing liens on a property. Refinancing generally results in the original home loan being paid off and a new loan getting issued with the new interest rate. Chronologically, that would put the new loan at the end of the line- but mortgage lenders require their loans to be first in line. In order to complete the refinance, other lien-holders would have to agree to be subordinate to the refinancing loan.

Unfortunately, not all lien-holders may agree to the subordination clause. For example, if you fall behind on your taxes, the IRS may put a lien on your home to ensure they get paid back. If you try to refinance, the IRS will have to decide whether or not to be subordinate to your loan. They may agree but, if they don't, your refinance may not be approved.

Finally, we have the Release clause

A release clause is a loan provision that allows an individual property in a blanket mortgage to be released from any liens by the lender. Blanket mortgages enable investors, builders, and developers to place multiple properties under a single loan, which is much more efficient than having multiple mortgages.

If the loan contains a release clause, a designated parcel or property is freed from any claims by the creditor once a proportional amount of the loan has been paid off, giving the borrower full rights to that property.