When you find a house you like and want to buy, it’s highly important to make a solid purchase offer. You want to show the seller that you are qualified (most importantly) and committed to buying the house. In many instances, you may include an escalation provision in your offer.
What Is An Escalation Clause?
The term “escalation clause” means the addition of a provision that you can include in a purchase agreement. This clause incrementally and automatically increases the price of your home by a specified amount over other offers until you reach the maximum price that you are willing to pay.
It only comes into play when the seller has received more than one bid to purchase the home or real estate property you’re interested in. It can include the following:
- Initial Offer: Your initial offer is the price that you are willing to pay for your home.
- Request Good Faith Offer: An inquiry to the seller asking for evidence that he has received another offer on the house.
- Escalation Value: Amount by which your offer will be higher than other offers. You can select any amount.
- Numbers of Escalations: How many times you are willing to increase the price.
- Price Cap: Maximum price you are willing to pay.
How Does It Work?
You can offer a price on a house in a standard transaction without escalation. However, if another person offers a higher amount, you will lose your chance to purchase the home. You can compete with bidders to buy the house when you add an escalation provision. The escalation clause is activated when the seller has received at least one bid that is equal to or greater than yours. The amount of your offer will then increase by the amount you have set as an escalation until you reach the price cap.
If the competing buyer includes a clause of escalation in their offer, then the price offered on the house will continue to rise until the price cap is reached.
Escalation Clause Example
You want to purchase a house in what is often referred to as a “seller’s market.” This means that homes are likely scarce and you may have to engage in more of a “bidding war” style format. This is where adding an escalation provision to your offer could “keep you in the running” for that property or listed real estate. You make an initial offer of $400,000; the escalation is $5,000, and your maximum price is $415,000. A buyer makes an offer of $403,000. The escalation is triggered, and your offer automatically increases to $408,000.
Then, one of two scenarios should occur:
- The bidder who does not have an escalation provision will win because you are now offering more money, $408,000 instead of $403,000.
- The offer price will continue to rise until the price cap is reached if the buyer competing has a clause that allows for an escalation. Say the buyer had an escalation clause of $3,000 and a maximum of $412,000. You would still win this bid because your maximum price ($415,000) is higher.
When To Use An Escalation Clause
Your real estate agent/broker should be able to help you to include an escalation provision in your offer. To do this, they will need to know how much money you are willing to spend in total and how much you wish to increase the price each time. In most cases, a real estate agent with experience can help you because they will know the local laws regarding escalation provisions and guide you through the entire process. real-estate attorneys can also help you review clause language.
In a market with limited inventory, an escalation clause is a great option. A home may receive multiple offers. Your agent may not be aware of the highest offer, but they do not want you to pay too much. You can increase your offer by small increments with the escalation provision. That said, keep in mind it’s a good idea to know your limits in advance. Your price cap shouldn’t be higher than what you can afford. This limit can be defined by a preapproval letter.
The Pros & Cons Of Escalation Clauses
You should always consider the downsides of an escalation provision.
Why You Should Consider Using An Escalation Clause
- This could help you win a bidding war. By being willing to outbid the other buyers, you gain an edge. You can use this to win a bidding war on a hot housing market.
- The bidding process is simplified. You can bid ahead of the competition without having to constantly adjust your price.
- Provides transparency. You will provide your highest offer upfront, eliminating any guesswork from the seller.
Potential Downside
- Prevents you from negotiating. Your highest price is revealed, which can reduce your bargaining strength.
- Increases the risk of paying too much for a house.
- The possibility of an appraisal gap. In the event that there is a difference between the final sale price and the assessed value, you will need to pay the difference out-of-pocket.
Who Should use an Escalation clause?
In certain situations, a clause of escalation can be used to help you get your offer accepted. This option is best for:
- Buyers of a home in a seller’s market. The clause protects you from having your offer rejected if a higher offer is made.
- Buyers that want to make their offer stand out. The clause tells the seller you are serious about purchasing the home.
- The clause is for buyers who are confident they can pay the maximum price. Monthly payments must fit your budget.
In some situations, it may be better to avoid an escalation provision. You may want to avoid an escalation provision if you cannot afford the maximum price. Some sellers will reject it outright. It’s also not a good idea to use an escalation provision if the market is a seller’s one because they only kick in when there are competing offers.
