Should You Use an Escalation Clause?

The past year has been a seller’s market with low inventory, houses selling for above asking, and steep competition. Buyers are using various tactics to set themselves apart in situations where there are multiple offers. One of these tactics is an escalation clause. Here’s a brief guide on this increasingly popular inclusion in offers.

What is an Escalation Clause?

An escalation clause, sometimes called an escalator, is when a buyer submits an offer on a home for sale and includes a clause in the contract. This clause states that they are willing to exceed the competitors’ offer by a certain amount of money in order to win a bidding war. The amount the buyer is willing to go over each time is clearly described, such as $1,000 or $5,000. This is called the escalating factor. The buyer will also include an absolute cap for how much they are willing to spend.

With an escalation clause, the buyer can also ask for “proof of a bona fide offer”, which is documentation proving other offers exist.

Escalation clauses are a longstanding part of real estate contracts in seller’s markets, but they have gained even more popularity since the onset of COVID-19. Pent-up demand and low inventory have made the market swing decidedly in favor of sellers.

Why Use an Escalation Clause?

1.  It saves time

An escalation clause is used to set an offer apart and make the process of counter-offers more seamless. With the clause included, buyers can save time by not having to rewrite the offer each time.

2.  It can help you keep to a budget

An escalation clause with a clear cap prevents a buyer from going over their budget during the fever fueled by a bidding war. 

3. It can prevent losing a bidding war by a negligible amount

If you learned you lost an offer on a $400,000 house by a mere $2,000, you’d likely be pretty upset. An escalation clause helps a buyer compete to the best of their ability.

4. They’re becoming expected

In a seller’s market, these clauses are becoming expected. Failing to include one may put a buyer at the bottom of the list of competitors.

Why You Might Not Use an Escalation Clause

1.  Sellers don’t always like dealing with them

If a sale closes with an escalator, the seller loses the ability to issue counteroffers to the other interested buyers.

2. When there aren’t other offers

The seller will know the buyer is willing to pay more than their initial offer, if the buyer includes this clause. If there are no other offers, this gives the seller the upper hand without any benefit to the buyer.

3. If you don’t have the cash to cover the appraisal gap

When a home has multiple offers, you can expect the final sale price to be above the original asking amount. When this happens, it’s possible the home will appraise for a lower value than the agreed-upon sale price. This leaves the buyer to cover the gap. If the buyer doesn’t have enough cash to do this, an escalation clause could put them in a difficult spot.

Conclusion

Navigating the buying process and evaluating offers can be a difficult and confusing process. We’d like to help you make the experience easier with our expertise. If you’d like to learn more or begin your home buying or selling journey, reach out to us at (877) 699-0353. We are ready to get you where you want to be.