A Guide To Escalation Clauses In Real Estate
When buying a home in a competitive market, you may find yourself in a bidding war with other interested buyers. If it’s for a home you really want, you can give yourself a competitive edge by including an escalation clause in your real estate offer.
What Is An Escalation Clause?
An escalation clause automatically increases the amount you’re offering for a home when a higher bid comes in. Sometimes called an escalator clause, an escalation clause usually includes the increments by which your bid can increase as well as a maximum offer.
Typically, an escalation clause is used when a bidder expects a property will receive multiple offers.
And while it can be a handy tool, adding an escalation clause to an offer is no guarantee you’ll end up with the winning bid.
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When To Use An Escalation Clause
Using an escalation clause can be especially beneficial in a seller’s market, which is when more buyers are in the market than homes for sale. A seller’s market often leads to bidding wars, in which several interested buyers make offers on the same property.
To have the best chance at winning, your real estate agent may advise you to include an escalation clause in your offer. Doing so can put you in the best position to have the highest bid.
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An Example Of Escalation Clauses In Real Estate
Imagine you find a home you want to buy and plan to make an offer of $375,000. But the neighborhood is in high demand, and you think the seller may receive multiple offers. To protect yourself from losing out to a slightly higher bid, you add an escalation clause that raises your offer if you are outbid by $5,000, up to a maximum of $400,000. If the seller receives a high bid of $385,000, the escalation clause would raise your offer automatically to $390,000, and you’d have the top bid. But you would be outbid if the seller gets an offer of $410,000, which is more than your maximum.
When setting an escalation clause, consider the seller’s asking price, the maximum amount you can afford for the home, and the incremental amount you’re willing to pay to beat competing bids.
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The Pros And Cons of Using An Escalation Clause
Before including an escalation clause in your real estate offer, you’ll want to weigh the pros and cons.
Pros
An escalation clause can provide the following benefits:
- It’s helpful in competitive markets. When several buyers are vying for the same property, an escalation clause can help you outbid the competition.
- It shows the seller you’re serious. While some sellers may not accept offers with an escalation clause, many view it as a way to discern which buyers are seriously interested in their property and how much they’re willing to pay.
- It prevents you from overpaying. With an escalation clause, your offer only increases when your seller can provide proof of a higher offer. This can protect you from paying more than necessary.
Cons
An escalation clause can have drawbacks, including:
- It limits negotiations. An escalation clause shows a seller upfront the maximum amount you’re willing to pay, which can weaken your negotiating position.
- It might inflate the sale price. A lender usually won’t finance any amount greater than the property’s appraised value. So, if your escalation clause makes the offered price higher than the appraised value of a property, you’ll have to cover the difference.
- Sellers may reject your offer outright. Some sellers may turn down offers with escalation clauses altogether because they want to see how high bidding will go.
Should You Use An Escalation Clause?
While including an escalation clause in every offer may be tempting, it’s best to use this tool sparingly. If there’s a home you absolutely love with multiple offers, then you might consider including an escalation clause in your offer.
On the other hand, an escalation clause may not be necessary when you’re not certain you want to buy the home, if multiple offers are unlikely or if you have other options on the table.
If you need help deciding whether to use an escalation clause, consult your real estate agent or attorney.
FAQ
Here are answers to common questions about escalation clauses.
The Bottom Line
An escalation clause can help you secure the home of your dreams while protecting yourself in a competitive market. While an escalation clause doesn’t guarantee the seller will accept your offer, it gives you the best chance by ensuring your bid can compete with other offers.
