Clauses in mortgage documents
A residential mortgage is a long contract, but the exam focuses on a handful of clauses. Learn what triggers each one and what it lets a party do.
Acceleration clause
An acceleration clause lets the lender declare the entire remaining balance due at once when a stated event happens, usually a default such as missed payments. The lender normally has to choose to use it; it does not fire on its own. The borrower then owes the unpaid principal plus interest already accrued, not all the interest that would have been charged over the rest of the term.
Acceleration is what makes foreclosure practical. Without it, a lender could only sue for each missed payment as it came due.
Due-on-sale (alienation) clause
A due-on-sale clause lets the lender demand payment of the full balance if the borrower sells or transfers the property. "Alienation" means transfer of ownership, so this is also called an alienation clause. It is a specific acceleration trigger: transfer, rather than missed payments.
The point is to stop a buyer from simply taking over a loan with a below-market rate. Federal law (12 U.S.C. 1701j-3) generally lets lenders enforce these clauses, with exceptions for certain transfers, such as some transfers on death or between spouses on divorce.
Prepayment penalty clause
A prepayment penalty is a fee for paying off the loan, or a large part of it, early, often within the first few years. It compensates the lender for interest it expected to earn. It might be a percentage of the balance or a set number of months of interest. Many loans have no prepayment penalty at all; when there is no penalty, the borrower may prepay freely.
Defeasance clause
To "defease" is to defeat or annul. A defeasance clause says the lender's interest is defeated when the borrower pays the debt in full: the mortgage becomes void and the lender must release its lien. It protects the borrower, and it is the reason the lender owes the borrower a release (covered in Lesson 3).
Escalation clause
An escalation clause lets the lender raise the interest rate when a stated event occurs, such as a default or a change in an index the contract names. It changes the rate, not the due date.
Subordination clause
Liens are normally paid in order of priority, which usually follows the order of recording. A subordination clause or agreement is a lender's promise that its lien will rank behind another lien, even one recorded later. It is common when a landowner with a mortgage on a vacant lot needs a construction loan: the construction lender insists on first priority, so the lot lender subordinates.
Release clause
A release clause, often called a partial release clause, appears in a blanket mortgage that covers several parcels, such as lots in a subdivision. It lets the borrower free individual parcels from the lien by paying a set amount, so lots can be sold one at a time with clear title.
Quick comparison
| Clause | Trigger | Effect |
|---|---|---|
| Acceleration | Default (or other stated event) | Whole balance due now |
| Due-on-sale | Sale or transfer | Whole balance due now |
| Prepayment penalty | Early payoff | Borrower pays a fee |
| Defeasance | Full payment | Mortgage is void; lien released |
| Escalation | Stated event | Interest rate goes up |
| Subordination | Agreement between lenders | Lien ranks lower |
| Partial release | Payment of a set amount | One parcel freed from a blanket lien |
A frequent mistake is confusing acceleration with escalation. Acceleration speeds up the due date; escalation raises the rate.