Even in a slower housing market, I see homes that create competition.  These homes are usually move-in ready, in a desirable location, or have upgrades and renovations that buyers are searching for in a home.  When this competition for a home arises, some buyers elect to include an escalation clause in their contract in order to compete with other offers.  What is an escalation clause?  How do escalation clauses work? Are there any cons to using an escalation clause? Keep reading to find out.

What is an escalation clause?

An escalation clause is part of a written real estate offer that states that the buyers will raise their offer on a home if the sellers receive another competing written offer of a higher price.  

In real estate, we usually see this clause used in a competitive market or for a highly desirable home.

How does an escalation clause work?

The escalation clause states the original offer from the buyers.  It tells what increments the offer will increase in relation to a competing offer and designates the highest price the buyers are willing to pay for the home.

For example, the buyers place a $200,000 offer on a home with an escalation clause.  The clause states that the buyer will increase the offer $5,000 over the competing buyers offer up to a maximum purchase price of $230,000.  If an offer comes into the sellers for $210,000, then the escalation clause will automatically bump the buyers offer to $215,000. 

If the seller decides to use the buyers offer with the escalation clause, the seller must provide proof of the competing written offer that would activate the escalation clause. to the buyer.

When should I use an escalation clause?

Escalation clauses can be used to help a buyer compete in a multiple offer situation.  It can make the buyer’s offer more attractive to the sellers and shows that the buyers are serious about buying the property.  The cap in the clause prevents the price from going over the buyer’s budget.

Are there any cons to using an escalation clause?

Using an escalation clause does tell the seller’s the highest the buyers are willing to pay for the property before any negotiation have happened.  Using an escalation clause could push the list price over the appraisal’s home value.  In this case, the buyer may need to provide the funds for the difference between the list price and the appraisal price.  For example, the buyer’s escalation clause places the list price of the home at $315,000.  The buyer proceeds with the purchase using a mortgage.  During the appraisal, the value of the home is priced at $310,000.  Since the bank will not loan more than $310,000 to the buyers (the appraisal price of the home) the buyers will need to bring $5,000 to the closing in order to purchase the home.  

Escalation clauses can be a useful tool for a buyer to use when in a competitive situation.