What is an Escalation Clause?
August 11, 2020 2:24 pm
What is an Escalation Clause and is it a Good Idea to Use it?
In a strong seller’s market, there are more buyers and less inventory so the seller will often end up with multiple purchase offers. You, as a buyer, may spend a considerable time searching for the right house, finally find one you love, and begin the process of purchase by submitting an offer only to end up being outbid by a higher offer. In this case, the only thing to do is to start looking all over again. This often leads to serious buyer frustration. The escalation clause can be used as a solution.
What is an escalation clause?
An escalation clause states that you are willing to outbid any other offers on the home by a certain amount, up to a ceiling price. The ceiling is also referred to as a “cap price” or the most you are willing to pay.
For example, you found a home you would like to purchase, and the list price is $500,000. Here in Hermosa Beach or Manhattan Beach, home values are considerably higher, but we will use this price for the sake of simplicity.
You have been pre-approved for $550,000 and you absolutely love the home and will pay up to $550,000 but also don’t want to pay more than you have to so you put in a full price offer of $500,000. In such a competitive market, bidding wars are common and often a strategy among selling agents. Other bids come in, but you do not know what they are, if they will be countered along with yours, or if they will be accepted while yours is rejected. You do not want to lose the opportunity to buy this home but what can you do? How do you know how much to offer?
What you can do is add the escalation clause to your offer. It states you will pay $5000 more than the highest offer up to $550,000. So, if someone else submits an offer for $530,000 your offer then bumps up to $535,000. This will continue up to the cap on the escalation clause, which is the most you would like to pay, $550,000.
Is this a good idea to use the escalation clause?
If using the escalation clause, it is critical that you decide how much you love the home, and what your max price will be. It can be a saving grace in avoiding a bidding war or losing out on a home, but there are some things to think about.
If working with a loan officer to obtain financing, you want to be sure the house will appraise for the max price that you will be offering. Otherwise, you might tank your own loan or must come up with the difference in appraised value vs. price.
Your agent must be experienced and familiar with how it works and willing to explain it if the listing agent and/or seller do not. You do not want the seller to misunderstand and feel the contract is more complicated than it is. The escalation clause only deals with price and it is actually, pretty straight forward, but the seller might wonder why you did not just put your best and final in the first offer. Because he now knows your cap, he may then just counter your offer for that.
Please note that is illegal for the seller to make up prices to drive up your offer. You are entitled to request proof of the higher offer. This is not to say that no one has ever tried to commit fraud by having friends put in fake offers to drive up the price. This is another reason you will want to choose an experienced agent on your side that knows what to watch for.
It is only a good idea to use the escalation clause if you understand what you are committing to and are comfortable with it. We recommend including a cover letter to your offer to avoid any confusion. Happy house hunting and good luck!
