Should You Use an Escalation Clause?
These sharp bids on purchase offers can backfire
An escalation clause is language inserted into a purchase offer for a home that's intended to make sure a buyer is the highest bidder. It's typically used when a buyer and their real estate agent strongly believe a house will receive multiple offers.
An escalation clause states that the buyer will pay a certain amount of money above the highest offer the seller receives. It generally includes a ceiling cap to make sure the buyer doesn't agree to pay more money than they can afford.
Learn more about escalation clauses and how they work.
What Is an Escalation Clause?
An escalation clause improves the odds that a home buyer will submit the highest offer. It typically includes three parts:
- Proof of an offer: Sellers can only use the escalation clause if a higher offer than the bidder's comes in. It can't be used arbitrarily to increase the home's sales price.
- Escalation amount: The language will specify the amount by which the buyer will outbid other offers.
- Price cap: This is the highest amount the buyer is willing to pay for the property.
How an Escalation Clause Works
Let's say a seller has listed their property at $295,000 in a seller's market—one in which there's a great demand for homes and prices are rising. The home has all the bells and whistles a buyer could possibly want and it's located in a desirable neighborhood on a quiet cul-de-sac.
The listing agent has advised buyers that all offers will be presented to the seller on a certain day at a certain time. That's a clear indication the agent expects to receive more than one offer on this plum property.
The seller receives offers of $290,000, $295,000, $305,000, and $305,000. The fourth buyer's offer includes the following escalation clause: "Buyer agrees to pay $1,000 more than the highest offer received by the seller, not to exceed a sales price of $315,000."
The buyer has agreed to pay $1,000 more than they would have without the escalation clause and they have ensured no one could have outbid them among the initial offers.
In a buyer's market, you typically don't need to worry about an escalation clause as there's low demand for homes and buyers have the upper hand. It may be worth considering for a particularly desirable property that's likely to get multiple bids, though.
Considerations for the Seller
If the seller accepts the offer with the escalation clause, they can no longer issue multiple counteroffers to the other interested parties nor can they continue to negotiate with the highest bidder. If the buyer was actually willing to pay $315,000, the seller lost that $9,000.
A seller who accepts an offer with an escalation clause will never know exactly how much higher the final price for the home might have gone.
It could be in the seller's best interest to issue counteroffers instead of accepting the bid with the escalation clause. There is no limit to the number of counteroffers that can go back and forth. Depending on the state, a seller can make a different counteroffer to each buyer or sometimes to just one or two buyers.
The seller might find the third buyer has decided they're willing to spend $325,000 on such a prime property, and so the seller will get $30,000 more than the listing price.
Another option for the seller is to raise the sales price of the home to $325,000 and start the bidding process all over again.
Considerations for the Buyer
While an escalation clause can make an offer more attractive, it also shows the seller exactly how much you're willing to pay. You may come out with a better deal if you negotiate with the seller. The escalation clause also doesn't account for other points of negotiation. For example, if your seller counteroffers, you could offer a shorter timeframe for inspections to sweeten your offer. An escalation clause could limit your negotiation options.
The Bottom Line
An escalation clause can be a useful tool, but it has drawbacks for buyers and sellers alike. If a buyer is considering making an offer with an escalation clause, they should consider contacting an attorney. The clause should be written by a lawyer, not by the buyer's real estate agent. The seller has the right not to respond to any offer, whether or not it contains an escalation clause.