Escalation Clause: What Is It And How Does It Work?
Kevin Graham5-minute read
September 30, 2021
House hunting can take a while, so when you find a house you like that’s within your budget, you want to put in a good offer. You have a top end in mind, but you also don’t want to pay more than you have to. In the seller’s market much of the nation finds itself in, an escalation clause could allow you to outbid other potential home buyers without showing your hand right away.
What Is An Escalation Clause In Real Estate?
An escalation clause is a section in the offer letter that states the buyer will raise their offer if the seller receives a higher offer from a different buyer.
Escalation clauses are often used in hot markets as a counter against multiple offer scenarios. It prevents you from bidding against yourself, but it also keeps you from losing your opportunity at the house to a competing offer because you didn’t go absolutely as high as you were willing to with your initial offer.
How Does An Escalation Clause Work?
The way an escalation clause is written, you start with your initial offer on a house. Then there’s language written in that says if someone outbids you, you’ll go $X above their offer up to $X. You just have to know the highest you’re going to go for that particular house. You can work with your real estate agent to determine what the increment of your escalation clause should be if you’re outbid.
Now that we’ve gone over the mechanics, let’s touch briefly on the advantages and disadvantages.
Pros Of Escalation Clauses
There are several benefits of escalation clauses, particularly in a hot market. Let's run through a few of them.
- Peace of mind: You may still lose out on the house, but it won’t be because you didn’t put your best offer forward when you could have bid more. If you do have to move on, you can do so with a clear conscience.
- Won’t overpay: At the same time, the escalation clause only kicks in when there’s a higher bid than what you’re offering. You’re not bidding against yourself.
- Increases the odds of getting the house: In a hot market, things can move fast. An escalation clause saves back and forth and allows you to put a competitive offer on the table when you’re outbid.
- Prove investment to the seller: If you’re willing to put an escalation clause into the contract, this can show a seller and their REALTOR® how serious you are about your offer.
Cons Of Escalation Clauses
For all of their advantages, escalation clauses have downsides as well. Here they are:
- Trust is hard: You might be asking yourself what prevents the seller from making up an offer just to trigger your escalation clause? You can ask the seller for proof of an offer, but many times the personal information is removed. Even if it’s included, it’s unlikely you’ll be able to judge the person’s seriousness and interest in the home. Why would they tell you anything when you’re their competition?
- The seller may not want to play ball: When you make an offer that includes an escalation clause, the seller knows your top offer. They may instead counter with an offer at that price point. You could theoretically create a version of an escalation clause with no defined limit but subject to your approval. However, sellers are aware that they can’t count on this and they couldn’t be blamed for rejecting it until you made a real offer at a price point.
- There is a counteroffer disadvantage: This might seem a bit counterintuitive but automatic escalations could actually put you at a disadvantage when going against other bidders. You know your purchase price is going up, but you don’t know what else others might be offering to sweeten the deal. Maybe they’re offering more flexibility on moving dates and there’s no appraisal contingency. You won’t necessarily have that visibility.
- Multiple offers with escalation clauses can be messy: If a seller is confronted with multiple buyers who have included escalation clauses in their offer, things get really hard to keep track of very quickly. Because of this, a seller may bring you all to the table and ask you to submit your highest and best offer at that point, defeating the purpose of an escalation clause.
- Appraisal becomes crucial: If, like most, you’re buying with a mortgage, the lender won’t give you more than the house is worth because the home is collateral for the loan. Where this becomes tricky is if the appraisal of the home comes in below the agreed upon price in your purchase agreement. If that happens, you’ll either have to renegotiate with the seller or being the difference between the appraised price and the purchase price to the closing table along with your down payment. This could happen in any transaction, but the inclusion of an escalation clause where the price has been bid up a few times may increase the likelihood of this happening.
Escalation Clause Example
Before we close this article out, let’s bring the song together with a fully fledged example. Let’s say Jane is looking to bid $350,000 on a three-bedroom colonial. But she doesn’t want to get outbid below the top line of her budget. Let’s take a look at the escalation clause she and her buyer’s agent cook up.
The buyer will initially offer $350,000. In the event this offer is outbid by another potential buyer, she’ll pay $5,000 above any offer up to $400,000.
Escalation doesn’t kick in until someone bids higher than $350,000. Jane is also prevented from getting into a bidding war that gets out of control because her top dollar offer is defined up front.
The Bottom Line
An escalation clause is a provision in real estate offers that allows you to make an initial bid that rises by a certain amount above competing offers each time you get outbid before ending at the top dollar amount you would be willing to pay for the home. Although this sounds like a good idea because you know you’re going down with the best offer you could’ve given, there are also drawbacks.
One drawback is that a seller may not want to deal with an escalation clause and may ask for your highest and best offer. Additionally, it’s hard to know for sure how serious other buyers are without tipping them to the fact that you’re their competition and they are not likely to tell you much. Finally, the seller knows your best offer is at the top end of your clause.
Every situation is different. If you’re unsure of your best course of action, you should consult your real estate agent. If you’re looking for one, our Verified Partner Agents would love to work with you. You may also be looking at your mortgage options. We invite you to get started online.
Not quite ready yet? Check out more on the home buying process.
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