What is an Escalation Clause?

By Realty Times Published Oct 5, 2023 12:42 pm

With the limited inventory of homes, low interest rates, and generally competitive market in housing, the idea of an escalation clause is particularly relevant right now. Below, we cover what escalation clauses are and when you might need one.

An Overview of an Escalation Clause

An escalation clause is something you can include in your offer if you’re attempting to buy a home. This clause is one way to win a home when there’s a bidding war or competition for it.

An escalation clause is something you might include in your offer that guarantees you’ll increase your agreed-upon price if there’s a specific factor determined. In real estate offers, an escalation clause will state that if another offer is made on the property, your bid will automatically go up by a certain amount so that your offer will remain the highest.

An escalation clause can state that initially as a buyer, you’re willing to pay a particular price. Then, you’ll go up to a pre-determined limit if competing offers are received.

You might add this clause if you’re pretty sure a property will receive multiple offers, which your real estate agent should be able to offer you guidance on.

With that being said, even if you have an escalation clause, there’s no guarantee you will be the successful bidder.

How Does It Work?

If you find the perfect home for you and you make an offer of $300,000, but you suspect that the house will receive at least one other offer, you put in the escalation clause, theoretically. You might, as an example, say that if you’re outbid, you’ll go up $10,000 over any other offers. You can say that your highest bid will be $310,000.

Most of these clauses are set up to gradually and incrementally increase your offer at set amounts whenever someone outbids you.

The ceiling is an integral part of this so that you don’t spend more than you can afford. Also, if someone puts in an offer that’s above your ceiling, you’re outbid.

In a seller’s market, which we’re in right now, an escalation clause can be beneficial.

If you’re going to put in an escalation clause, you need to consult with a professional first, whether a real estate agent or an attorney. They’ll help you figure out whether your situation calls for it, as well as what your amount should be and your ceiling.

For an escalation clause to go into effect, the seller must prove the competing offer. Sellers can’t use your escalation clause to get you to pay more for the home.

Are There Risks?

Escalation clauses can be helpful when you’re in a competitive market, but a downside to consider is that you have to lay it all on the line from the start. You’re telling a seller right away how much you’re willing to pay for the house. That means their counteroffer can be your ceiling price. You also don’t necessarily have any way of knowing whether the offer competing with yours was legitimate or not.

Additionally, not all sellers prioritize the highest price when accepting an offer.

Tips for Using Escalation Clauses

If you’re thinking about making yourself a more competitive buyer with an escalation clause, you need to be realistic. Base your price ceiling on your financial situation and your preapproval letter. You also have to remind yourself that you can still be outbid.

Don’t use an escalation clause on every house. Use it strategically and when you’re genuinely in love with a home.

You might also want to include an appraisal contingency if you’re going to add the escalation clause. With an appraisal contingency, once the home is appraised, it has to meet the agreed-upon purchase price. You don’t want to end up paying more than the market value for the home.