It’s no secret that the real estate market has been exceedingly tight. In many areas, there are far more would-be buyers than sellers. Sellers are being overwhelmed with multiple offers on their properties, while buyers are growing increasingly frustrated with bidding wars.
If you’re a buyer, could an escalation clause be the answer to your problems? Possibly. Here’s what you need to know and consider:
What’s an Escalation Clause in Real Estate?
An escalation clause is a provision written into an offer on a home that automatically bumps up your bid in comparison to other offers that the seller may receive – up to a predetermined maximum.
A sample escalation clause might work like this: You view a home that is listed for $200,000, and you fall in love with it. You’d be willing to pay up to $220,000, or 10% above the home’s listing price – but you don’t want to pay more than you must.
With an escalation clause, you can hedge your bets. For example, you can offer $200,000 on the home with the provision that if – and only if – the seller gets a competing offer that’s as high or higher than yours, the escalation clause kicks in.
Once the escalation clause is triggered, it automatically increases your bid in $2,000 increments (or whatever amount you decide to build into the clause) until you either exceed all other bids or hit your maximum of $220,000. So, if another buyer bids $205,000 on the home, your bid would automatically increase to $207,000.
In short, an escalation clause is a way of signaling to a seller that you are extremely serious about buying their home – and that you have the means to do so. Even if the incremental bumps in your escalation clause are fairly modest, including one can make your offer stand out in the seller’s mind.
What Are the Pros and Cons of an Escalation Clause?
Escalation clauses can help you secure the home you want, but they’re not without their flaws.
Their biggest “pro” is that escalation clauses can ease a buyer’s anxiety about their bid since they can straddle the line between “not quite enough” and “too much.” Sometimes, escalation clauses are often paired with appraisal gap coverage so that buyers have the additional security of knowing that they won’t pay more than the home is worth.
Also, by their very nature, escalation clauses eliminate the stress of the offer-counteroffer process that’s so common in a competitive market. You set your maximum, and the escalation clause takes it from there.
For many buyers, that kind of stress relief is worth the money. The drawbacks of this approach, however, can be significant. For example:
- You’re putting all your cards on the table at once. An escalation clause isn’t something you want to automatically include in every offer because you’re telling the seller exactly how much room you have with the price. You’re also conveying a sort of desperation about the property that eliminates a lot of your bargaining power. It should only be considered when you and your real estate professional are pretty certain that a seller will receive multiple offers fairly quickly and you really want the home.
- An escalation clause can put both the buyer and seller into a bind. Unless a buyer has plenty of cash laying around, the buyer is still likely to be limited to what the mortgage company will pay. If the appraisal on the home isn’t high enough to cover their bid, a buyer may still have to pull out of a deal. That potential can lead sellers to be cautious about all the extra dollar signs they’re seeing.
Finally, it’s important to note that adding an escalation clause doesn’t necessarily guarantee that you’ll get the home – even if your bid is the highest. There are a lot of factors, tangible and intangible alike, that can influence which offer a seller accepts. Everything from your willingness to offer extended moving time to the seller to your earnest money deposit to the general impression you made on the seller (if you met) can sway their decision-making process.
What’s the Final Verdict on Escalation Clauses?
When every potential buyer is looking for an edge in a difficult market, there’s no right answer. Just like a preapproval on your mortgage from a lender, an escalation clause is just one more tool in the toolbox when it comes to finding – and securing – the home of your dreams. Combined with an appraisal contingency, it could be a wise move for many bidders.
An escalation clause can draw attention to your bid and make your offer more attractive to the seller, but there are some hefty drawbacks that should be factored into the equation. Before you decide if an escalation clause is right for you, it’s wisest to discuss both the pros and the cons with your real estate professional.
