Whether you are house shopping or considering selling your property, it is important to do your due diligence and become familiar with the language used in real estate transactions to avoid misunderstandings and confusion.
Contacting an experienced real estate agent is a big part of a successful transaction, but you will have an advantage if you’ve already done your homework.
We’re here to help with the answers to seven FAQs about real estate escalation clauses.
What’s an escalation clause in a real estate contract?
The escalation clause (also called an "escalator clause") in a real estate contract allows a home buyer to make multiple offers on a house without having to bid over and over again. After making an initial offer, a buyer can stipulate in the purchase agreement that if any other higher offers are made, they will automatically raise their offer a certain dollar amount above subsequent offers from other buyers up to a certain limit, or ceiling.
For example, as a buyer, if you initially bid $300,000 on a house and knew that your limit was $320,000, you could ask the seller for an escalation clause that would beat any higher offer by, say, $2,000. So, if another buyer bids $305,000 after your initial offer, your offer would then automatically increase to $307,000. This bidding would continue until you hit your ceiling of $320,000.
When should you use an escalation clause as a buyer?
In a seller’s market, when competition for homes is high, it can be frustrating as a buyer to have to make multiple offers in a bidding war.
The escalation clause can give a highly motivated buyer some peace of mind during the stressful negotiation process. They don’t have to worry someone else will steal their dream home with a better offer unless the bid exceeds the limit that they set in the escalation clause.
What are the pros of an escalation clause in a real estate contract?
For a home buyer in a seller’s market, the obvious value in an escalation clause is that it gives the buyer peace of mind that they won’t miss out on a house that they really want. In addition, because they have written in a limit on their bidding, they run less of a risk of overpaying for a house if things start heating up and they let emotions take over.
Also, other potential buyers may get frustrated and give up bidding if every time they bid they are automatically outbid. If this happens, the escalation clause has the possibility of getting a buyer a house at a decent price before hitting the limit they set for their budget.
What are the cons of an escalation clause in a real estate contract?
The biggest drawback of the escalation clause is that the clause gives the seller too much information about what a buyer is willing to pay for a home. A buyer is basically showing all his cards to the seller from the beginning.
The seller may choose to ignore offers with escalation clauses or even make a counter offer at the ceiling set ($320,000 in our example) to wipe out the clause and continue to accept traditional offers.
Finally, lenders may not deal with escalation clauses at all. Remember that banks require an appraisal to process a mortgage. An escalation clause can create a situation where the winning bid is above the appraisal value which means the buyer would be on the hook for additional financing.
Are escalation clauses legal?
While escalation clauses are not illegal, they do bring up controversial issues. A seller accepting a contract with an escalation clause is accepting an agreement of purchase and sale with an ambiguous price. This can create confusion and it is not uncommon for misunderstandings to end up in court.
Another important issue is whether subsequent bids on a house can be proven to be authentic. The seller does not have to reveal personal information of the other potential buyers nor the amount of the offers.
What are the dangers of using escalation clauses?
Buyers should note that escalation clauses only consider the price of a home. In other words, they only address the amount you are willing to pay for the property itself. They do not include other terms such as compromises on closing costs. This can cause confusion and disagreements. A seller may have another offer that is more attractive as a package without raising the price on the house.
In addition, it may be near to impossible for a buyer to get financing when using a contract with an escalation clause. One agent estimated that 98% of the banks he worked with refused offers with escalation clauses.
What is an acceleration clause in real estate?
An escalation clause should not be confused with an acceleration clause. An acceleration clause can come into play after a house is purchased with a mortgage. It allows the lender to immediately demand the full amount of the outstanding balance on a mortgage, including accrued interest, if certain circumstances aren’t met.
An acceleration clause is most often triggered if you miss mortgage payments, become delinquent on your property taxes or don’t purchase home insurance. The acceleration clause can push a house into immediate foreclosure if a homeowner cannot meet the demand for full payment.
You can avoid the acceleration clause from coming into play by understanding and following the terms of the financing contract.
Because selling or buying a house can be the largest and most difficult transaction you may perform, make sure you have the guidance of an experienced real estate agent. Clever Partner Agents are the best in their local markets.
In addition, both buyers and sellers can save big with a Clever Partner Agent. If you are selling, find out how you can save on commission with a Clever Partner Agent. If you are buying, you may be able to qualify for a Home Buyer Rebate.