What Is An Escalation Clause In Real Estate And How Does It Work?

House hunting can take a while, so when you find a house you like that’s within your budget, you want to put in a good offer. You have a top end in mind, but you also don’t want to pay more than you have to. In a seller’s market, an escalation clause allows you to outbid other potential home buyers without showing your hand right away.

What Is An Escalation Clause In Real Estate?

An escalation clause is a section in the offer letter that states the buyer will raise their offer if the seller receives a higher offer from a different buyer.

Escalation clauses are often used in hot markets as a counter against multiple offer scenarios. It prevents you from bidding more than you can afford. It also prevents you from losing out to a competing offer when buying the house because you didn’t go as high as you were willing to with your initial offer.

How Does An Escalation Clause Work?

An escalation clause is written so that you start with your initial offer on a house. If someone outbids you, you’ll go a certain dollar amount above their offer up to a specific dollar limit. You just have to know the highest you’re willing and able to pay for that particular house.

You can work with your real estate agent to determine what the increment of your escalation clause should be if you’re outbid. They’ll also help you decide how much to offer as a starting point and where your budget should max out.

Escalation Clause Example

Let’s say Jane is looking to bid $350,000 on a three-bedroom colonial and the top of her budget is $400,000. Let’s take a look at the escalation clause she and her buyer’s agent prepare.

Jane will initially offer $350,000. If this offer is outbid by another potential buyer, she’ll pay $5,000 above any offer up to $400,000. Escalation doesn’t kick in until someone bids higher than $350,000. Jane avoids a bidding war that gets out of control because her highest offer is defined upfront.

Pros Of Escalation Clauses

There are several benefits of escalation clauses, particularly in a hot market:

• You’ll make your best offer. You may still lose out on the house, but it won’t be because you didn’t put your best offer forward. If you do have to move on, you can do so knowing you offered as much as you could.
• You can avoid overpaying. An escalation clause allows you to increase your offer up to a certain amount, meaning you won’t have to spend beyond your means. If you worked with your agent to set a maximum budget that isn’t more than the home is worth, you won’t have to worry about overpaying for a house.
• You can increase your odds of getting the house. In a hot market, things can move fast. An escalation clause can reduce back-and-forth and allow you to quickly put a competitive counteroffer on the table if you’re outbid. It’s a common method buyer’s use to try to win in a seller’s market.
• You’ll prove your investment to the seller. If you’re willing to put an escalation clause into the contract, it can show a seller and their REALTOR^® – a licensed agent – how serious you are about your offer. If another buyer backs out or their financing falls through, the seller and agent might be more likely to come back to you for consideration.

Cons Of Escalation Clauses

For all of their advantages, escalation clauses have downsides as well:

• You may have to request proof of higher offers. If the seller says they received a higher offer that would put an escalation clause into effect, you may want to request proof of a bona fide offer. This is documentation that shows proof of the legitimate, good faith offers from other buyers. It’ll exclude personal information. This extra step may not add a lot of time to the process, but it can certainly be added work for the seller.
• The seller may not want to play ball. When you include an escalation clause, the seller knows your top offer. They may instead counter with an offer at that price point. You could theoretically create a version with no defined limit, subject to your approval. However, sellers may feel they can’t count on this and reject it until you make an offer at an actual price point.
• You may still have to include other incentives. You know your purchase price can increase, but you don’t know what else others might be offering to sweeten the deal. Maybe they’re offering more flexibility on moving dates and no appraisal contingency. An escalation clause alone may not compete as well with these offers with contingencies or flexibility.
• Multiple offers with escalation clauses can get complicated. If a seller is confronted with multiple buyers who have included escalation clauses in their offers, it can become hard to manage. A seller may ask all potential buyers to submit their highest and best offer, defeating the purpose of an escalation clause.
• Your purchase price could exceed the appraisal amount. If you’re buying with a mortgage, the lender won’t give you more than the house is worth. This becomes tricky if the home appraisal comes in below the agreed upon price. If it does, you’ll have to either renegotiate or pay the difference between the appraised price and the purchase price. This is more likely to happen when the price has been bid up a few times due to an escalation clause.

FAQs About Real Estate Escalation Clauses

Thinking about adding an escalation clause? You can better understand how it might impact you by reviewing some frequently asked questions from other home buyers.

What happens if two offers have escalation clauses?

Two offers with escalation clauses will escalate each other until one reaches its maximum and the other outbids it. If they have the same maximum dollar amount, the seller may request that both buyers put their highest and best offers forward.

Can a seller refuse an escalation clause?

Yes, a seller can refuse to consider offers that contain escalation clauses. Some sellers will see an escalation clause and interpret the buyer’s maximum budget as an unwillingness to negotiate. Other sellers want to cut the back-and-forth and see your highest and best offer for a quicker and easier sale.

When should I use an escalation clause?

Buyers should use an escalation clause to strengthen an offer on a home they’re serious about purchasing. If the home you want is receiving a lot of attention and your real estate agent anticipates the home will get numerous competitive offers, you may want to consider adding an escalation clause to help your offer stand out.

How do I write an escalation clause?

Your real estate agent can help you write an escalation clause into your offer. They’ll help you decide on the right increments at which to increase your offer and determine your price cap.

The Bottom Line

An escalation clause is a tactic buyers use to strengthen their offer on a potential home. They can be beneficial in a bidding war or a seller’s market. However, every situation is different. If you’re unsure of whether to add this clause to your offer, consult a real estate agent.

If you’re looking for an experienced agent, connect with one of our Verified Partner Agents from Rocket Homes^SM today. They can help you with finding the right home, writing an escalation clause into your offer and ironing out the important details.