You thought you found your dream home. You wanted it so much, you bid the full asking price. Someone else wanted it too, and they outbid you. If there was an escalation clause in your contract, you might have won that bid. Learn how this type of clause works and what it can do for you.
What is an Escalation Clause?
An escalation clause in a real estate contract automatically raises the offer to counter higher bids. It is not that different from bidding on online items. In such cases, you set your top bid, and win the item if no one outbids you. The escalation clause, also known as an escalator clause, works in a similar manner for real estate.
In effect, it eliminates the need for the listing agent to negotiate with competing bidders. How much you are willing to pay for the property is included in the contract. While this clause saves time, there are other benefits. Sellers know a buyer with an escalation clause in the contract really wants that property.
Elements of an Escalation Clause
An escalation clause in a contract contains three elements. These are:
- Proof of a bona fide offer – A seller cannot just claim another party made a higher offer on their home, thus triggering the escalation clause. They must prove there is another offer exceeding yours. Such proof generally consists of the competing buyer’s purchase agreement denoting the higher price, as submitted by the listing agent.
- Escalation amounts – Each contract specifies the amount by which you will outbid an offer.
- Price cap – A maximum amount above which you will no longer bid.
For example, if you made a bid on a house for $350,000, with an escalation clause of $5,000, your offer would increase to $355,000 if there was a competing bid. Sometimes percentages rather than dollar amounts are used. The contract might specify an escalation of 1 percent over your offer, which in this instance is an increase of $3,500.
Perhaps that $355,000 is your final offer. You could also set a price cap of $360,000. If the other buyer is willing to pay more than $360,000, you are out of the running.
Keep in mind, the clause only goes into effect if there are competing bidders. If you submit the highest offer and the seller accepts it, you pay that amount, not the escalated price.
When to Use an Escalation Clause
Consider using an escalation clause if you are house-shopping in a hot market and desirable homes receive multiple offers. The clause can make your offer stand out as sellers consider their next step.
When you really, really want a particular property, an escalation clause can help you obtain it.
When Not to Use an Escalation Clause
While it’s often beneficial, there are also situations in which you should not use it. Escalation clauses really only make sense there is a lot of buyer interest in the dwelling. In a buyer’s market, or when it is unlikely the house in question will receive multiple bids, there is no need for an escalation clause in your contract.
There are exceptions even in a buyer’s market. Some neighborhoods remain in demand even when sales in the general market are slow.
The downside of using an escalation clause is that the seller knows exactly how much you are willing to pay for the home. You’ve tipped your hand, and they know they can present you with a counteroffer at your price cap.
There are sellers for whom price is not the top priority. They may need to close on the property quickly, and the buyer who can offer a fast closing may prove more useful than one who will pay slightly more. Perhaps they want to sell the property as-is and prefer a buyer willing to do their own repairs.
Sellers and Escalation Clauses
Not all sellers accept escalation clauses, as it can put them at a disadvantage. Once the offer with the escalation clause is accepted, counteroffer negotiations with other interested buyers are no longer possible. They could end up losing money in the sale.
How OVM Financial Can Help
At OVM Financial, we understand that buying a house is likely the biggest financial decision you will ever make. OVM is here to help you through the entire loan process. Along with our excellent service, we can work with challenging financial situations or come up with creative solutions so that you may become a homeowner. Buying your dream home has never been easier.
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