What is an escalation clause and how can it help you in the homebuying process?
- 5 min read
What we'll cover
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How escalation clauses work
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Benefits and drawbacks of escalation clauses
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Seller responsibilities
Whether you're a buyer or a seller, you want to have every option at your advantage in a hot real estate market. As a buyer, waiting for news of whether your offer will be accepted can be a real nail-biter, especially if you're in the middle of a bidding war .
Luckily, you have options like an escalation clause that can help you “stay in the game” when multiple offers come in for your dream home.
Read on to learn more about escalation clauses in real estate, how an escalation clause works, understanding the escalation amount and price cap, and the pros and cons to escalation clauses.
Escalation clause in real estate
An escalation clause is a provision in a real estate contract that automatically increases the offer amount on a home if the seller receives a higher competing offer. The clause states how much more the buyer is willing to pay. Another way to look at it: If other potential buyers outbid them, the escalation clause can protect the buyer from losing out on the home sale.
How does an escalation clause work?
The buyer’s real estate agent and the seller’s agent work together regarding escalation clauses. The escalation clause should contain the following:
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A bona fide offer: Sellers can’t simply claim they have an escalation cause in order to get a higher offer from you, the buyer. Nor can their friend submit an offer to escalate the purchase price. Instead, a seller must be able to provide proof of another, better offer than the one you provided. A bona fide offer must be legitimate and enforceable. The buyer may even require the seller to send documentation of the competing offer.
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The escalation amount: The escalation clause will include the amount which you’d like to outbid any other offers, or how much the price will escalate above a competing offer. For example, let’s say you choose an escalation amount of $10,000. If another buyer offers $200,000 for the seller’s house, the escalation clause would automatically increase your offer to $210,000.
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The price cap: The price cap represents the maximum purchase price in the case of multiple offers, or how high you’re willing to allow your offer to go.
Talk to your real estate agent about any other terms you might want to include in an escalation clause. Here’s how that might play out in an example. Let’s say you find the home you want in a very popular neighborhood. You offer $190,000 but add an escalation clause that states that if another buyer outbids you, you’ll exceed any other offers by increments of $10,000 (the escalation amount), up to $280,000 (the price cap).
Determining the escalation amount and the price cap
When you add an escalation clause to your offer, you’ll have to determine up front your maximum purchase price. Your existing budget and ideal monthly payment are important factors in determining your price cap and escalation amount.
In addition, it is always a good idea to get a mortgage preapproval from a lender before you decide on your price cap so you know how much you are able to borrower before committing to an offer amount. If working with a real estate agent , you should consult with them about the amount and price cap of any escalation offer you are considering.
Does the seller have to accept the escalation clause?
Sellers do not have to allow an escalation clause. They may prefer to get buyers’ best, final offer right off the bat. Sellers might not want to deal with an escalation clause because bidding wars are typically beneficial for a seller. Also, an escalation clause might feel like a game instead of a straightforward way to make an offer. A real estate agent can tell you whether making an offer with an escalation clause is a good idea.
What happens when there are multiple offers with escalation clauses?
When multiple offers with escalation clauses appear, the seller will evaluate the strength of each offer with the buyer’s commitment to complete the sale. Sellers will prefer the buyer that appears to be most serious about committing the purchase, and will consider things like:
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The amount of earnest money. Earnest money is a good indicator of how serious a buyer is. A buyer that puts down substantial earnest money may appear to be more reliable to the seller.
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A cash offer. A cash offer indicates to a seller that the buyer is serious.
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Waiver of contingencies. A buyer might waive the right to a return of their earnest money if they back out of the sale, or waive other contingencies like appraisal, inspection and financing contingencies. A buyer who waives contingencies signals to a seller that there won’t be delays in the sale process.
What is the maximum purchase price in case of multiple offers?
In the case of multiple offers, a buyer may have one opportunity to put their best foot forward to submit an offer in a “best and final” strategy, in which all competing buyers can offer a final offer. The seller can then select an offer outright instead of multitasking several offers with each individual buyer at once.
Benefits and drawbacks of an escalation clause
Next, let’s look at the benefits and drawbacks of an escalation clause in real estate — why or why might you not want to roll one into your offer? Let’s take a look at both the pros and cons.
Benefits of the escalation clause
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Can help in a competitive market: An escalation clause can protect both buyers and sellers when the home might receive multiple bids. Buyers may avoid losing out on a home by having some price flexibility. A few thousand dollars extra could secure your dream home, and really might not be a hitch if the amount still falls within your budget.
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Can speed up the process. The escalation clause can reduce the back and forth between each buyer’s agent because the next offer is already known.
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Only offer: If your initial offer is the highest or only offer the seller considers, then the purchase price will not increase – which would allow you to secure the home at a price point lower than you were willing to pay.
When you add an escalation clause to your offer, you’ll have to determine up front your maximum purchase price. Your existing budget and ideal monthly payment are important factors in determining your price cap and escalation amount.
Drawbacks of the escalation clause
The seller knows your maximum offer. The seller will know what you’re planning to offer and the maximum cap price from the get-go, which impacts your ability to negotiate for a lower price. This gives the seller an upper hand in the negotiation process.
Summary
When you find your dream home and want to make an offer, an escalation clause can help you eliminate homebuying stress and stay ahead of other offers that may come in on the home.
It’s important to remember that the escalation clause isn’t a guarantee that the seller will accept your offer. Some sellers may not want to deal with an escalation clause.
It would be a good idea to speak with a real estate agent about whether an escalation clause makes sense for your situation, and, if so, they can help you write it into your offer.
Ready to get started? Ally’s mortgage calculator can help you determine how much you can afford.
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