Real Estate Contract Penalty Clauses

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What Are Real Estate Contract Penalty Clauses?

Penalty clauses in a real estate contract usually impose penalties on the mortgage lender or borrower if they violate certain terms. In most cases they are imposed by the mortgage lender upon the borrower, though this may change depending on the contract terms. 

The most common type of penalty clause is called a “pre-payment penalty clause”. This is a penalty that is imposed upon the borrower if they attempt to make a mortgage payment before the date or time period stated in the contract. While it may seem like mortgage lenders would prefer an early payment, in some cases the lender may actually lose profit if the mortgage is paid off too quickly. 

Therefore the mortgage lender may require the borrower to only make the payments in regular, cyclical payments, and not earlier. Early payments may result in penalties imposed on the borrower, such as a monetary fee.

Are Penalty Clauses Enforceable?

Pre-payment penalty clauses are only enforceable if both the lender and borrower agree to the terms stated in the clause. The prepayment clause is almost always embedded as an included clause in the original mortgage contract. Thus, when the borrower signs the mortgage loan document, they must be informed if there is a penalty clause in the contract.

If the prepayment clause isn’t included in the original contract, or if one of the parties doesn’t agree to it, it is not enforceable under real estate and contract laws.  In such cases, a violation would not result in any penalties for the lender, since the penalty clause isn’t enforceable to begin with.

What if a Penalty Clause is Violated?

If the penalty clause is correctly executed, both the lender and the borrower may face legal consequences if they violated the terms of the clause. For example, if the lender does in fact make an early payment, the borrower has the legal right to enforce a penalty according to the clause. 

If the borrower doesn’t pay the penalty fees, the lender may take them to court and sue them for penalty payments. This is because the penalty clause is subject to basic contract principles; as such, a violation of the clause will be remedied in a similar way to a breach of contract claim.

Do I Need a Lawyer for Help With a Real Estate Contract Penalty Clause?

Real estate contracts are very important for all parties who participate in a real estate transaction.  Penalty clauses are a common aspect of many real estate contracts. If you need help having a penalty clause drafted, reviewed, or edited, you should contact an experienced real estate lawyer for advice.  Your attorney will be able to explain how penalty clauses can affect your real estate transaction.  In the event of any violations or disputes, your lawyer can provide you with professional representation in court. 

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Last Modified: 11-13-2013 11:01 AM PST

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