What Is An Escalation Clause And When Is The Time To Use One?

It’s not uncommon for sellers to receive more than one offer in a hot real estate market. Depending on market conditions, an escalation clause may be necessary to purchase your dream home. An escalation clause in a competitive seller’s market may be your secret to winning a bidding war.

What Is An Escalation Clause In Real Estate?

An escalation clause, or escalator, is a section in a real estate contract that states that a prospective buyer is willing to raise their offer on a home should the seller receive a higher competing offer. The clause establishes the maximum a buyer is willing to pay over the highest offer. An escalation clause protects buyers if other potential buyers outbid them because it keeps them within their predetermined budget.

Generally, an escalation clause shows a seller how serious a buyer is about a property and how far they’re willing to go to buy a home. In most cases, an escalation clause puts a preset cap on how much a buyer will spend to beat other offers.

How Does An Escalation Clause Work?

The main components of an escalation addendum include:

• What is the original purchase price?
• How much will that price escalate above a competing offer?
• What is the maximum purchase price in the event of multiple offers?

It’s also important to note that a clause will also include the amount in increments a buyer will pay should their offer be accepted.

Generally, escalation clauses and offers are communicated between the buyer’s REALTOR^® and the seller’s real estate agent. An escalation clause is triggered when the seller has proof of a bona fide offer from another buyer. This means that the offer is legitimate and enforceable. Essentially, a seller cannot make up another offer.

A buyer and their REALTOR^® must fully understand what they are doing when adding an escalation clause to the offer. It’s wise to consult with a real estate attorney to ensure both parties fully understand the implications of this binding agreement.

Escalation Clause Example

For example, let’s say a buyer submits a $300,000 purchase offer with an escalation clause that says they’ll pay $5,000 more than any other buyer, up to a total of $315,000. If another buyer submits a $305,000 offer, with the escalation clause, the first buyer can top the competing offer, increasing their offer to $310,000, beating the competing offer by $5,000.

When Should I Use An Escalation Clause?

Escalation clauses can be beneficial, especially in a seller’s market. If homes are selling fast, you’ll need something to help make your offer stand out in a competitive market and signal to sellers that you mean business. So, the best time to use an escalation clause would be during a potential bidding war scenario.

However, escalation clauses aren’t foolproof and may not make sense for your situation. Talk to your REALTOR^® or real estate attorney to discuss the effectiveness of this strategy. If you go ahead with it, decide how much you’re willing to spend, helping you avoid feelings of remorse if a bidding war starts.

Pros And Cons Of An Escalation Clause

It’s important to know the pros and cons of an escalation clause. Let’s dive into both below.

Pros

Some of the advantages of using an escalation clause in a purchase offer can include:

• Peace of mind: Using an escalation clause can give you more confidence when buying a It allows you to stay competitive while ensuring you stay within your budget.
• A more attractive offer: An escalation clause shows the seller that a buyer is serious about a They may factor in the clause when deciding which offers to consider.
• Prevention from overpaying: An escalation clause can shield you from paying more than necessary to get your offer accepted because your offer only increases when another buyer makes a higher offer.

Cons

While escalation clauses have their advantages, they also have some disadvantages that can include:

• End to negotiations: Because the clause reveals the maximum amount a buyer is willing to pay, the seller knows the buyer’s highest offer, which can eliminate the opportunity to negotiate. The capped amount may weaken the buyer’s bargaining power because the seller can reject the escalation clause and counter with the buyer’s highest revealed offer.
• Rejection of lower offers with escalation clauses: Because buyers may not submit their highest offer with an escalation clause, sellers may reject their offer because it limits their ability to counter offer other buyers.
• High escalations may cause issues with appraisals: An escalation clause can cause the offered price to exceed a property’s appraised value. While a buyer may win the bidding war, a lender typically won’t finance above a home’s appraised value. In this case, the buyer must cover the difference in cash to purchase the home.

The Bottom Line

If you’re considering an escalation clause, consult with a real estate agent or REALTOR^®. They can help you understand the intricacies of including the clause with your offer. Working with someone who understands the pros and cons of escalation clauses can help you confidently navigate a competitive real estate market.

An escalation clause is one way to show sellers you’re serious about buying their home. Another way is to submit a preapproval letter with your offer. If you’re ready, get preapproval through Rocket Mortgage^® and start down the path to finding your new home.