Let’s say you’re a home buyer in a hypercompetitive seller’s market and every home you want seems to have multiple offers on it. Stressed might be the right word to describe how you’re feeling – especially if every time you make an offer, there’s a bidding war and a buyer outbids you.
A few things could be at play here. Maybe you’re not sure how to up your bid, and sellers and listing agents are having a hard time taking you seriously. Or maybe you’re afraid of upping your bid because you’re worried that you’ll offer more than you can afford in the heat of the moment.
If you’ve found yourself in either (or both!) of these situations, you may want to consider adding an escalation clause (aka an escalator or price escalation clause or real estate escalation clause) to your next offer.
What Is an Escalation Clause?
An escalation clause gets written into the purchase offer/real estate contract or written offer on a home. It states that:
- You are a buyer submitting an initial offer.
- If another buyer puts in a higher offer, you will escalate (aka raise) your offer by matching the competing offer and adding a fixed amount.
- You will continue to escalate by a fixed amount until your offer reaches its maximum limit.
- You will either continue to escalate until the other buyer stops making offers and you have the winning bid, or the buyer makes an offer that’s higher than your max spending limit.
If you’ve ever been to an auction or were a big fan of “Storage Wars,” it’s pretty much the same thing: an item goes up for sale and bidders compete to take the item home. The crucial difference, though, is that the seller already knows your maximum price before the bidding begins.
Terms to know
If you’re going to play to win, you’ll need to know what everyone is talking about first! Here are the terms most commonly associated with escalation clauses:
- Escalation amount (or escalation factor): It’s the amount you will “escalate” your bid above a competing offer. It can be any number, but it’s usually a round number.
- Ceiling (or price cap): It’s the maximum amount you’re willing to pay. Once the escalation hits your ceiling cap, you can’t escalate anymore.
- Number of escalations: Depending on how you structure your escalation, you may only allow for one escalation, a predetermined number of escalations or multiple escalations until you hit your price ceiling.
How does an escalation clause work?
Let’s say you want to buy a home that costs $250,000.
You put in an offer at the sale price – but the neighborhood is popular, and you just know there will be competing bids.
So, you and your real estate agent thought ahead and included an escalation clause in your offer with an escalating factor of $2,000, an unlimited number of escalations and capped your spending limit at $275,000.
Here’s how that might play out:
|Competitor’s Offer||Your Offer With|
Escalation Factor ($2,000)
|$273,000||$275,000 (final offer)|
If the competitor doesn’t offer more than $275,000, the home could be yours. If the competitor offers more, the escalation stops and you move on to the next house.
When Should You Use an Escalation Clause?
An escalation clause can be a valuable way to keep you competitive when you’re trying to get a new home. But you want to use it at the right time and place.
When the market is competitive
If you live in a hot housing market and expect lots of home buying competition, an escalation clause can help keep you in the running. Also, if you really want a home, adding an escalation clause to your offer can signal to the seller that you’re serious about buying.
When the seller is doing a 1-day review
Some sellers welcome a long, drawn-out, back-and-forth bidding war. Other sellers choose the drama-free route. They collect their offers and make their decisions quickly and definitively.
The drama-free option is sometimes referred to as a 1-day review. With a 1-day review, the seller announces the time frame buyers have to submit their offers. Once the submission period is over, they review all of the offers at once.
Adding an escalation clause to your offer can help keep it in the “under serious consideration” pile. The seller doesn’t have to wonder if you’d be willing to offer more; your minimum and maximum are in the offer, and they’ll compare it with the other offers they’ve received.
When you can pay more than the appraised value
When you’re applying for a mortgage, your lender will require a professional appraisal to determine the fair market value of the house you want to buy.
With an escalation clause, you might find yourself in the position of buying a house for more than its appraised value, and the lender may not be willing to extend the extra money you’ll need to cover the difference.
You’ll need to have more cash available upfront to cover a larger down payment.
When Should You Not Use an Escalation Clause?
Of course, an escalation clause isn’t always the right option for every situation. There are times when putting in a simple offer and leaving room to negotiate is the better choice.
When the market isn’t hot
If you’re not in a seller’s market or you’re buying a home during a slow period in your local real estate market, an escalation clause might not be a good idea.
If a seller sees that you’re willing to escalate your bid, they’ll know that you’re willing to pay more for their home, and they may try to negotiate a higher sale price.
When the seller isn’t a fan of escalation clauses
Adding escalation clauses is a common practice – but not every seller is a fan. Some prefer to negotiate offers the old-fashioned way with a traditional back and forth, or they’d rather just get your best offer upfront and skip the incremental offer increases.
It will be up to you or your real estate agent to talk to the seller first to determine whether an escalation clause makes sense, even in a hot seller’s market.
When you’re worried about breaking your budget
The thing to remember about an escalation clause is that it can escalate. And when it does, you have to honor the offer you’ve made. So, when you put in an escalation clause, make sure that you are both willing and able to pay (or get a mortgage to cover) the cap or ceiling.
What If There’s More Than One Offer With an Escalation Clause?
Well, first off, don’t panic! In a hot real estate market, you can expect multiple buyers to submit offers with escalation clauses.
Now, usually, the buyer with the highest ceiling has the best chance of getting their offer accepted. But sellers may take other factors into account – like whether the seller is offering to pay cash, the type of loan the buyer’s getting or even a personal connection – when deciding which offer to choose.
What Happens if Someone Violates an Escalation Clause?
An escalation clause is a legally binding contract. Breaking it could lead to civil fines, and your real estate agent could risk losing their license.
As a buyer
Buyers should never make offers they aren’t ready to make good on. Make sure that you and your real estate agent are on the same page before you add in an escalation clause.
Otherwise, you’re legally required to start the home buying process and put down an earnest money deposit. If you pull out of the deal before you buy the home, you risk losing the deposit and/or getting sued.
That’s why, in addition to your escalation clause, you may want to include contingencies in your purchase offer.
Contingencies are specific conditions that must be met before finalizing the home sale. If they aren’t met, you can back away from the deal penalty-free if there are problems with the home, or you’re concerned about getting approved or being able to sell your own home to cover the costs.
As a seller
Sellers need to deal honestly with prospective home buyers.
A buyer has the right to ask you for a “proof of offer” or “proof of a bona fide offer” to prove that there was another offer that triggered the escalation clause.
If a buyer asks, you’ll have to provide proof that there was a legitimate, competing offer. If you can’t provide that proof, you and your real estate agent could both be in trouble.
The Escalation Clause: An Offer You Can’t Refuse?
An escalation clause can be a strategic way to play your cards and get your offer accepted. But it can limit your ability to negotiate because you’ve laid all your cards out on the table for the seller to see.
Before including an escalation clause in your next real estate offer, talk to your real estate agent or a real estate attorney. They can help you decide if it’s the right move for your situation, and they can help you understand everything you’re committing to.