Worried that the home you want to buy will be snatched up by a more aggressive buyer? You’re not wrong to worry, especially in competitive markets.
To improve your odds of getting the home you want, consider using an escalation clause, which allows you to increase your offer and, hopefully, outbid any rivals.
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An escalation clause in a real estate contract indicates that you, the buyer, agree to increase your offer if the seller receives a higher bid from another buyer.
“An escalation clause is an offer to pay above the listing price with a predetermined maximum amount,” explains Jeff Satre, a production manager with Fairway Independent Mortgage Corporation (which owns Home.com) in Ashburn, Va. “The escalation clause usually states the offer will exceed any other bona fide offer by a set amount – $1,000 over the offer, for example.”
Not all offers demand an escalation clause.
“An escalation clause is used when the buyer and/or Realtor expect multiple offers on a property,” Satre explains.
Including an escalation clause can help get a seller’s attention and keep you in the game if other buyers are making highly competitive offers as well.
“An escalation clause allows you to pursue a more flexible and powerful offer as a homebuyer. This way, you can put in an offer but also stipulate the highest price you are willing to spend,” says Michele Harrington, chief operating officer for First Team Real Estate in Irvine, California.
Say you make an offer for $530,000 on a home for sale. Including an escalation clause in your contract that goes as high as $545,000, for example, can help you win a possible bidding war and demonstrate to the seller exactly how much you’re willing to pay, Harrington adds.
Your agent or real estate attorney should draft your escalation clause as part of your offer on a home.
An escalation clause typically comprises at least three key components, according to Glen Pizzolorusso, an associate real estate broker with Compass in Fairfield County, Conn.
The key components of an escalation cause
- Original purchase price: This is the amount you’ve offered on the home in your initial bid for the property
- How much you’re willing to go above a competing offer: This can be listed in dollar amounts or as a percentage
- Maximum amount you’re willing to offer: This is the ceiling on what you’d be willing to pay for the house
Pizzolorusso recommends that your escalation clause include language similar to the following:
- “Buyer will pay $___more than any other competing offers, up to a sale price of $____.”
- “Seller will provide the buyer proof of other competing offers prior to execution of the contract.”
- “Execution of the offer is contingent upon the buyer’s written receipt and approval of other competing offers.”
Escalation clause example
Here’s an example of how an escalation clause, also known as an “escalator,” works, from Fairway mortgage advisor Dan Chapman:
“You can set the escalator in whatever increment you prefer – say it’s a $500,000 initial offer, but the buyer is willing to pay up to $550,000. The realtor can make the escalation clause in increments of, say, $1,000 over the maximum competing offer up to $550,000. So if the competing offer is at $540,000, the buyer gets it for $541,000.”
In other words:
- Original price: $500,000
- How much you’re willing to go above a competing offer: $1,000
- Maximum amount you’re willing to offer: $550,000
Let’s say a competing buyer made an offer of $510,000. Per your escalator, your offer would increase to $511,000 – $1,000 above their offer. Then they increase their offer to $520,000, and a second competing buyer offers $525,000. Your new offer would increase to $526,000, which is $1,000 more than the highest competing offer.
A thousand dollars is just one example. Your escalator can include increments of more than $1,000, or it could be a percentage. For instance, you might increase your offer by 2% of the highest competing offer up to your maximum purchase price.
Bruce Ailion, a real estate attorney in Atlanta, Ga., notes that an escalation clause must be worded very carefully to spell out exactly how much you’re willing to pay.
Additionally, “your escalation clause should require the seller to show you the offer you have competed against,” he says.
Other language may also be required, depending on the laws in your state, the real estate agency/brokerage you choose, and other factors.
Escalation clauses are often strongly recommended by agents or attorney representatives when it’s likely that a seller will receive multiple offers on a property.
“In today’s seller’s market, with lots of multiple offer scenarios, it can be exactly what a buyer needs to win the home they want,” says Harrington.
Sellers usually accept escalation clauses because it means multiple offers are involved, which can significantly raise the selling price of the home for sale.
However, when several offers come in for the same home, too many escalation clauses may complicate matters for everyone involved, especially the seller.
“Sometimes, if there are more than five or so offers, escalation clauses can get lost in the mix, and it can be confusing for the listing agent to decipher all of them,” cautions Valerie Weber, a Realtor in Charleston, South Carolina. “When there are more than five offers involved, I usually recommend that my buyer client comes in at their highest possible price with no escalation clause included, which can impress the seller and land them the home they want.”
Escalation clauses have their advantages and disadvantages. Consider the following:
|You have a better chance of winning a bidding war||If you win the house at your maximum purchase price, you have less cash available for renovations and other home expenses|
|You can avoid overpaying for a property. Your offer will only go up if and when another buyer puts in a higher bid||Multiple offers might lead to appraisal issues, as escalating offers may drive the purchase price above the actual market value of the home|
|The escalation clause will signal to the seller that you’re committed to buying the home||Your ability to negotiate is diminished because the seller knows the highest price you are willing to bid|
Won’t the seller just raise their price to your highest escalated offer?
It’s possible that the seller will simply counter-offer at the top of your escalation amount, even if there are no other offers. There are no laws against it. This is one reason escalation clauses shouldn’t be taken lightly. In this situation, it could backfire, causing you to pay more for the house.
Submitting your offer as your highest and best is a good idea in many cases, even if you have a bit of wiggle room on price. An escalation clause is a little bit like laying your poker hand down on the table for your opponent to see. So have a serious conversation with your agent on when it’s appropriate to add an escalator.
One tip is to have your real estate agent add to the escalation clause that only verifiable and legitimate competing offers can trigger the escalation clause. You don’t want the seller’s second cousing writing up a bogus one-sentence offer just to drive up your price.
3 tips for making an escalation clause work for you
If you’re in a hot market and expect to find yourself in a bidding war, here are some tips if you decide to use an escalator:
- Choose an increment that works for you and the seller: You should be comfortable with the number, but it needs to be compelling enough to catch the seller’s interest. “Typically, I suggest that my buyer clients offer $1,000 over the highest offer. At higher price points, I recommend $2,000 or more over the highest offer,” Weber says
- Pick a “no regret” number for your ceiling. Emotions can run high when homebuying, and you may get so attached to a property that you’ll take it at any cost. But that can leave you in a financial bind if you don’t think rationally through the numbers beforehand. “I advise my buyers to decide ahead of time on a ‘no regret’ number – this is the price ceiling at which they won’t regret missing out because it was higher than they are financially comfortable with,” Weber adds
- Include an appraisal gap: “An appraisal gap is when you agree to cover any shortage between the offer price and the appraised value, which serves as a kind of insurance for the seller when offer prices jump much higher than the list price,” says Harrington. “A high offer can feel like a false promise if the buyer is relying on the loan and the home doesn’t appraise for its full value. Offering an appraisal gap along with an escalation clause is sometimes what it takes to win a bidding war in a fiercely competitive market right now with such limited inventory.”
If you are selling a home, Weber recommends only accepting an offer with an escalation clause if it includes this appraisal gap addendum.
Escalation clause in real estate FAQs
An escalation clause can help you outbid one or more rival buyers and land the home you desire. Using an escalation clause can tell the seller that you are a serious candidate, and the highest price listed in your escalation clause can sway their decision. Using an escalation clause can also help prevent overpaying for a property.
You need to be careful that you are comfortable with and can afford the highest possible price you are willing to pay, as indicated in your escalation clause. Also, be aware that a multiple offer situation could lead to a problem with the appraisal if the contract price is higher than what your lender or appraiser determines the house to be worth.
Additionally, note that your ability to negotiate the sale is decreased after an escalation clause is accepted because the seller immediately knows the highest price you are willing to bid. And, if the seller accepts your escalation clause, they can’t issue a counteroffer to other buyers, which could cause them to reject your escalation clause.
No. Another offer could be attractive in other ways besides price. Another buyer could offer to close in 7 days with no inspections, which would beat your offer of a 30-day closing with multiple inspections, despite your higher offer.
Your real estate agent or real estate attorney will draft your escalation clause as part of your offer, if you decide to include one. Escalation clauses are not mandatory, even in situations when there are multiple offers on a home.
Language in an escalation clause may look like the following:
– “Buyer will pay $___more than any other verified competing offers, up to a sale price of $____.”
– “Seller will provide the buyer proof of other verified competing offers prior to execution of the contract.”
– “Execution of the offer is contingent upon the buyer’s written receipt and approval of other verified competing offers.”
Using an escalation clause in your transaction can make a big difference.
“I think it’s an excellent tool for buyers and should be utilized in most notable offer situations,” Weber says.
However, it’s important for your agent to contact the listing agent of the property and ensure they understand the language and mechanics of your escalation clause, Pizzolorusso advises.
“Otherwise, it’s best to come in with your highest and best offer right upfront and keep your fingers crossed,” he says.