What Is An Escalation Clause?

An escalation clause is a way for anxious potential home buyers to try and make sure that they don’t lose a home they really want to buy.  If prospective buyers want a home in a market where competing offers are common, it shows great interest and a willingness to pay more.

It is an addition to an offer that lets the potential buyers say they are serious.  An example of an escalation clause –

The prospective buyers will pay $1,000 higher than any other offer up to $250,000. If the seller received two other offers at $225,000 and $235,000, their offer – with the escalation clause – would kick in at $236,000.

This allows prospective buyers to put in a bid and feel more confident that they will still get the home as – long as no other buyer outbids your cap or max bid.

The escalation clause only increases an offer when other buyers are competing with you. The final price is intended to be as close as possible to the lowest price needed to get the home.

In theory, an escalation clause is fairly simple. In practice, there are a lot of details involved.  An experienced Realtor™ who understands the in’s and out’s of escalation clauses will make sure prospective buyers understand all the potential issues. 

Here are the major pros and cons of using this approach that buyers should be made aware of:

Pros:

  1. An escalation clause can keep a buyer in the game to get a house they REALLY want.
  2. It can also protect buyers from overpaying when making an offer. Using incremental increases with a cap means you may only end up paying a small amount over the next highest offer.
  3. Prospective buyers can request to see copies of the other competing offers to verify terms.

Cons:

  1. You are showing your hand by telling the seller the highest price you are willing to pay, and the sellers can use your offer for leverage against the others.
  2. If the prospective buyers’ ceiling is really $321,000, why did they start by offering $300,000? The sellers may think “If they REALLY want the home, they have been willing to put all their cards on the table.”
  3. Don’t mistake price for value. With or without an escalator clause, any lender will only feel comfortable funding a mortgage for the appraised value.

The purchase price offered for a home is only one of several important factors used in evaluating the viability of the potential for a prospective buyer actually successfully becoming the owner of the property.

Other factors include appraisals, inspections, successful financing, warranties, and possession after closing.

If you do decide to use an escalation clause, be sure you understand all the advantages and disadvantages.  As always, being an informed decision maker is a big advantage and puts you in control.


 

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