The current short supply of available homes coupled with low-interest rates has led to competitive bidding wars over properties. This sometimes prompts buyers to add an escalation clause to their offer on a house. What is an escalation clause, and should you use one?
What is an escalation clause?
An escalation clause or addendum may help a buyer win a bidding war on a house with multiple offers. The buyer’s offer states a price, but the escalator states that she will increase her offer by a stated incremental amount over any competing offer up to a maximum cap. For example, suppose buyer Jones offers $150,000 to a seller and adds an escalator saying she will pay $2,000 over any competing offer up to a maximum sales price of $165,000. If buyer Brown offers $160,000, Jones’s escalator clause will automatically raise her offer to $162,000 and she will have the best offer. But if buyer Smith offers $166,000, Smith walks away with the deal because his offer exceeds Brown’s cap of $165,000.
When using an escalation clause, always set a maximum price you can pay and stick to it. Do not let the competitive bidding market push you beyond what you can afford.
Pros of using an escalation clause
An escalation clause makes sense only when the buyer expects stiff competition in a fast-paced, competitive sellers’ market. An escalation clause keeps you in the game automatically, up to your maximum offer price. If you believe the house you want will receive multiple offers and that your initial offer may not win, an escalator may be right for you. An escalation clause may also help you where a seller and his agent set deadlines for receiving and reviewing offers, at which time the seller will choose the winner.
Realize that by including the escalator you have revealed how much you actually are willing to pay. The seller may counter with a higher price, even up to your known maximum. Or the seller may keep you on hold, letting other offers come in, knowing that he cannot lose since your offer is automatically set to increase. If no better offers come in, you have no reason to pay more than your starting amount.
The seller may reveal to all the potential buyers what the highest bid has been and ask if one of them is willing to beat it. If this bid is above your maximum, your escalator clause will no longer allow you to win the bidding war; you must decide to stick to your maximum price or lose out.
Pitfalls of a clause
- If competing buyers are also using escalation clauses, a fast-moving bidding war will break out, driving up the price.
- Some sellers will not accept escalator clauses, preferring that competing buyers make their best offer right away.
- If you use an escalation clause, include language that the seller must show documentation of higher offers, known as “proof of a bona fide offer,” to trigger your escalator.
- In some states, you will be required to have an attorney draft the escalation clause, which will add to your costs.
- Escalation clauses put the focus on winning a bidding war based solely on the price you offer. But remember there are other offer terms you can use to sweeten the deal, such as offering to pay some of the seller’s closing costs, remaining flexible on the closing date, waiving the contingency to sell your house before closing, and/or offering an all-cash purchase if you are in a position to do so.
Related – Competing Against an All-Cash Buyer