Escalation Clause Guide: How They Work and When to Use Them

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• Escalation clauses incrementally increase your offer on a home if the seller receives higher bids, up to a maximum price.
• Including one in your purchase offer can help you stay competitive without overpaying for a home.
• This isn't always the best strategy, so work with your real estate agent to determine how you should craft your offer.

In a hot housing market , crafting the perfect offer can greatly improve your chances of getting the house you want.

Homebuyers are often asked to submit their "highest and best" offer when making a bid to purchase a home. But most buyers don't have unlimited funds to work with, and submitting an offer that's too high puts them at risk of overpaying for a home.

Including an escalation clause in your real estate purchase contract can help keep your offer competitive while avoiding paying more than you need to secure the deal. Here's how these clauses work.

Definition of an escalation clause in real estate

When used in a real estate purchase contract, an escalation clause lays out how much a buyer is willing to increase their offer if the seller receives higher offers from other buyers.

When and why escalation clauses are used

An escalation clause can help a buyer remain competitive when a home they want receives multiple offers without having to worry about paying more if they don't have to. Whether including one with your offer actually helps you achieve these goals is very dependent on the circumstances of the home sale and any other offers the seller receives.

"On the plus side, it can help your bid stay competitive and stay within a determined range , " says John Walkup, co-founder of real estate data analytics company UrbanDigs . "On the minus side, you've shown the seller your max price."

If you're wondering if you should include an escalation clause in your offer, talk to your real estate agent . They should be able to gather some intel on the sale and get an idea of whether an escalation clause could help or hurt.

How escalation clauses work

Key components of an escalation clause

An escalation clause will include three things:

• Your offer
• How much you're willing to pay above a competing offer
• The maximum amount you'll pay for the home

The escalation clause should also specify that the seller must provide copies of the other offers to prove that they've received higher bids.

This will all be included in the contract you send to the seller, along with all the other details of your offer.

Escalation clause example

Say you're submitting an offer on a $250,000 home. Your initial offer is for $250,000, but you also include an escalation clause stipulating that you'll pay $3,000 more than any competing offers that are higher than yours. You'll ultimately pay up to $270,000 for the home.

If the seller receives no other offers, then the most you'll have to pay is your original $250,000 offer.

After you submit your offer, the seller receives another one for $255,000. Per your escalation clause, your offer is now bumped up to $258,000. If the seller accepts your offer now, that's the amount you'd pay for the home.

But the seller receives a few more offers, the highest of which is $280,000. Because this exceeds what you said you were willing to pay, you're no longer in the running to buy the home.

Benefits of using an escalation clause when buying a house

An escalation clause can show the seller that you're truly interested in purchasing the home. From the seller's perspective, the more motivated you are, the less likely it is that the deal will fall through. This can make your offer more attractive.

By employing an escalation clause, you can also be sure that you're sticking to your budget and avoid any heat-of-the-moment bidding wars.

These clauses can also help you avoid overpaying for a home. Since you don't know how much other buyers are going to offer, an escalation clause ensures that you're only paying a certain amount above other offers. And if the home doesn't have any other competing offers, you'll only pay your initial offer amount.

Risks and considerations

However, there are situations where including an escalation clause in your offer could ultimately hurt you. There are even some circumstances where you could end up paying more than you would have without the clause.

Potential for overpaying

A home's sales price is separate from its market value. Once an offer is accepted, the buyer's mortgage lender will order an appraisal to determine what the home is actually worth.

A home appraisal is a report that states what a property's fair market value is based on recent similar home sales. If you make an offer with or without an escalation clause that is higher than the home's appraised value, you'll need to either overpay for the home, negotiate with the seller, or walk away. If you're using a mortgage and want to move forward, you'll need to bring more of your own cash to the transaction.

The higher you bid, the more likely you are to overpay. When determining the maximum amount you'll pay, talk with your real estate agent about whether the home is realistically worth what you could end up paying for it.

Be sure your max bid is also in line with your monthly housing budget. Don't take on a bigger mortgage payment than what you can afford.

"Keep in mind that while an escalation clause can make your offer more competitive, it's essential to set a reasonable cap to avoid exceeding your budget," says Michael Yehuda, a real estate agent with Coldwell Banker Warburg

Another concern: You outbid offers that aren't as good as your initial, lower offer.

Sellers don't always pick the highest offer they receive. Let's go back to our previous example:

You make your initial offer of $250,000 with an escalation clause to outbid higher offers by $3,000, up to $270,000. In addition to your offer, the seller also receives one for $260,000, so your bid automatically goes up to $263,000. But perhaps this other bid is from someone who doesn't have a strong mortgage preapproval , or their offer includes a lot of contingencies. Even without the escalation clause, the seller might still go with your offer if they feel it's ultimately more attractive.

With the escalation clause, you potentially paid $13,000 more than you had to.

It could put you at a disadvantage

When you include an escalation clause in your offer, you're telling the seller your highest possible offer right out of the gate. This can limit your negotiating power.

Additionally, some sellers won't accept offers that include escalation clauses. So you may be limited in the homes you can make these types of bids on.

How to craft an effective escalation clause

The best way to craft a successful escalation clause it to work closely with your real estate agent. They should be an expert in the local housing market, so they can tell you if an escalation clause is likely to increase your odds of success.

They'll also be able to talk to a property's listing agent to find out the process the seller is using to review offers.

Escalation clause in 2024: How it could help you buy a house this year

Mortgage rates should go down a bit this year , which may boost homebuying demand and increase competition among buyers.

If you're buying in a hot market, an escalation clause can give you the edge you need to get into a home.

"In a competitive real estate market like New York City, an escalation clause can still be beneficial, given the high demand and limited inventory," says Yehuda. "However, it's crucial to assess the market trends and consult with a local real estate professional to determine the most effective strategy."

Escalation clause FAQs

What is an escalation clause in real estate?

When you submit an offer to purchase a home, you can include in the contract an escalation clause that stipulates you're willing to pay more than other competing offers a seller receives, up to a maximum price.

How does an escalation clause protect a buyer?

Escalation clauses can help you stay competitive as a buyer, while helping you avoid overpaying for a home.

Are there any drawbacks to using an escalation clause?

An escalation clause could lead you to pay more for the home than its appraised value. You could also end up outbidding offers that are weaker than your initial, lower offer.

How can I ensure my escalation clause is effective?

Work with your real estate agent to determine if an escalation clause is appropriate for the property you're trying to purchase. Be sure you can afford the higher price, even if it ends up at your maximum amount.