The home buying process can be challenging, especially in a competitive real estate market.
With multiple buyers interested in the same properties, your purchase offer could wind up being just one of several competing offers a seller receives.
A real estate escalation clause could help your offer stand out from the competition.
Let’s look at what an escalation clause is, what to include in yours, and when to talk to your agent about adding a clause.
What is a real estate escalation clause?
An escalation clause is a condition you can include in your purchase offer for a home. It’s there to ensure you’re the highest bidder on the house.
Escalation clauses, sometimes called escalator clauses, are common in hot real estate markets or when your real estate agent has reason to believe the house you want will receive multiple offers.
An escalation clause typically says that you’ll pay a certain amount above the highest offer that a seller receives.
An escalation clause usually includes a “ceiling cap” or a maximum purchase price to protect the buyer from unintentionally agreeing to pay more for the home than they can realistically afford.
Escalation clauses can vary depending on the specifics of a situation, but there are several common elements present in all escalation clauses, including:
- Your initial purchase offer price
- Your ceiling cap
- How much your offer will “escalate” above a competing offer
Let’s look at an example of a real estate escalation clause
You found the home you want to buy and make an offer of $200,000.
After discussing the situation with your real estate agent, you include an escalation clause in your offer.
The clause says that if the seller receives a competing offer for more money, your offer will automatically increase by an increment of $3,000 above any competing offer.
Your escalation clause has a ceiling cap or maximum price of $230,000.
You submit your offer, and another buyer also submits an offer.
Their offer is for $205,000. In this scenario, your offer increases automatically to $3,000 more than the competing offer of $205,000 because of the escalation clause. So your new offer to buy is now $208,000.
But, if the other buyer increases their offer to $229,000, your offer would not automatically jump to $3,000 more. Because your escalation clause has a maximum of $230,000, an increase of $3,000 would be more than you authorized i.e., $229,000 + $3,000 = $232,000.
In this example, the other buyer would be the highest bidder.
Pros and cons of the escalation clause
If the real estate market where you want to buy a home is very competitive, or you think the house you want will receive multiple offers, you may want to include an escalation clause.
Let’s examine the advantages and disadvantages of escalation clauses.
Escalation clause pros
Including an escalation clause in your offer tells the seller that you’re willing to pay more for their home, if necessary.
Escalation clauses can also help protect you from getting emotionally caught up in a bidding war if one occurs by ensuring you don’t offer more than you can realistically afford.
If the seller doesn’t receive multiple offers, your initial offer remains at your starting bid.
In a competitive market, home sellers can look favorably on escalation clauses because they know the buyer really wants the home and is financially able to make that happen.
Additionally, a real estate escalation clause generally streamlines the contract and decision-making aspects of the home buying process, something sellers typically appreciate.
Escalation clause cons
One of the disadvantages to including an escalation clause with your purchase contract is that it lets the seller know what your final offer will be—how much you are ultimately willing to pay for their home.
Rather than accepting your offer, a seller could potentially ask for a higher offer from you. But it’s important to remember you’re under no obligation to increase your original offer.
Another escalation clause disadvantage is that certain sellers want to encourage a bidding war for their listed property. In this scenario, sellers typically don’t accept purchase offers containing an escalation clause.
The appraisal gap
Buyers should consider the appraisal gap when considering an escalation clause.
Because lenders typically don’t approve mortgages or refinancing loans for more than a home’s value, if your maximum purchase price is more than the home’s appraised value, you’ll have to pay that difference in cash.
When to talk to your real estate agent about an escalation clause?
Your real estate agent can be a great resource when deciding whether to use a real estate escalation clause. Because they have up-to-the-moment market details, they can provide the information necessary to help you make an informed decision.
Deciding whether to use an escalation clause requires:
- Careful consideration of your financial situation
- Understanding the appraised value of the home you are interested in buying
- Understanding your real estate market and whether you expect the seller to receive multiple competing offers
Contact Assist Home Loans
When it comes to buying a home, the more prepared you are when you submit your offer, the better your chances of its being successful.
- Don’t rush your offer
- Work with your real estate agent
- Don’t “guesstimate” how much you can spend
Get pre-approved for your mortgage, and find out how much you are qualified to borrow.
If you’re ready to begin the application process, start your mortgage application on our website.
Contact Assist Home Loans today and talk with a home loan specialist about the options that would be best for you.
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