WHAT ARE mortgage clauses? They are provisions found in mortgages that outline special rights, powers or benefits available to the borrower or lender. Since mortgage contracts can vary widely, there are many different types of clauses that can be included in them. As a result, it is important to carefully review any contract that you sign.
Here are a few types of mortgages clauses that you might encounter:
One clause is an assumption clause. This allows the home seller to pass the responsibility for the existing mortgage to the home buyer. In some instances, the buyer may be able to assume the seller’s interest rate.
From the buyer’s point of view, an assumption clause might be valuable to include in a mortgage as the buyer can avoid settlement costs and the mortgage application process. Negatives of an assumption clause include the interest rate of the loan not being acceptable and the possibility of many fees being charged and conditions being required.
Another clause that you may come across is an acceleration clause. This is a tool that allows the lender, in certain circumstances, to demand that the entire balance of the loan be immediately paid in a lump sum. The amount paid includes the interest that has accrued since the acceleration clause was invoked. The borrower, however, is not compelled to pay the interest that would have accrued over the duration of the loan.
The borrower missing a few payments is a scenario in which an acceleration clause could become relevant. Usually, the lender is required to provide the borrower notice that payments are being missed and give the borrower time to correct the situation. The solution for the borrower is to restore the lender to the same position that the lender would have been in had the borrower’s default never happened. If the borrower does not do this, the lender may begin the foreclosing process on the property.
On the opposite side of the spectrum are prepayment clauses, which grant the borrower the right to pay off the loan without penalty before the loan’s maturity date. Prepayment clauses are often found in consumer mortgages, but are rarely seen in commercial mortgages.
The privilege of having a prepayment clause significantly benefits the borrower because the borrower can pay back the principal of the loan and save money by not having to pay back future interest that would have accrued. This sounds like a great deal to the consumer, and it usually is — lenders include prepayment clauses in their contracts to encourage borrowers to choose them rather than a competitor.
Many loans often include a clause known as an escrow covenant. This requires the borrower to pay homeowners insurance premiums and property tax in installments to the lender in advance. The lender holds these funds in a separate account until the payments are actually due. The tax and insurance bills are then submitted to the lender and subsequently paid from the escrow account.
While escrow might sound like a burden to the borrower, it is a clause that protects homeowners by automating the process of sending timely and accurate payments for insurance and property tax.
A clause frequently found in adjustable-rate mortgage (ARM) contracts is a conversion clause. The interest rate on an adjustable-rate mortgage can increase or decrease over time depending on various factors. A fixed-rate loan, on the other hand, has a set interest rate and a fixed payment amount that won’t change for the duration of the loan.
A conversion clause allows a borrower to convert the ARM to a fixed-rate mortgage. A borrower might want to do this because changing to a fixed-rate mortgage makes the future payments more predictable. In most cases, the borrower must give the lender 30 days’ notice before converting. Be aware that there could be fees for doing this.
With all mortgages, keep in mind that the borrower is required to maintain property insurance against loss by fire and certain other perils. Laws mandating property insurance exist to protect lenders if anything unfortunate were to ever happen to the property. If a borrower does not obtain the appropriate coverage, the lender may obtain it at the borrower’s expense.
As with any contract, be sure to review and understand the terms of the mortgage prior to signing your name on the bottom line. Even if the closing attorney or settlement agent does not review every provision, it is necessary for the buyer to do so.