As the real estate market heats up during the coronavirus pandemic, buyers are encountering bidding wars more frequently, with houses for sale in short supply. To lessen the anxiety, you can append an escalation clause to your offer, which might help you snag the home. But tread cautiously and know what you are signing up for.
An escalation clause is designed to edge out competing bids by automatically raising an offer when a competing bid comes in. It’s also known as an escalator clause. Think of it like setting your maximum bid on eBay.
What is an escalation clause?
“An escalation clause is when a buyer is willing to go over the highest offer, up to a specified amount,” says Kristine Halverson of Compass in Santa Monica, California.
A buyer’s escalation clause is triggered by a competing offer. When that competing bid is made, the escalation clause automatically increases its own offer by a preset amount. The clause may or may not limit (or cap) the buyer’s maximum bid. For the clause to be triggered, sellers need to prove there was another bona fide offer, Halverson says.
Sometimes sellers or their agents resist using the clause, but she said they’re usually a pretty effective tool when multiple bids are likely.
Typically, a copy of a competing offer serves as the proof needed to trigger an escalation clause. But in practice, some agents say that kind of proof can be problematic.
Kaki Lybbert, a realtor with Century 21 and the National Association of Realtors Region 10 vice president, said it’s possible offers can be fabricated to trigger the clause.
“I don’t like them,” she said. “I think they’re not fair, I think they have risks on both sides, and that is probably why we don’t use them at all.”
Escalation clauses have been restricted by the Texas Real Estate Commission since 2016. Because they are much more complex than a standard offer, buyers in Texas are strongly advised not to use them, but those who choose to must do so through an attorney, not a realtor. One reason is there’s room for misinterpreting the buyer’s intentions.
“Sometimes a competing offer may be for a price, say (the seller wants) $300,000, but also (includes) $10,000 in buyer closing costs paid by the seller, so in effect, it’s $290,000,” says Rob Levy, principal broker with Keller Williams Realty Professionals in Portland, Oregon. “But the other buyer’s actual written offer is for $300,000, so the escalation can be interpreted as $310,000.”
If you do choose to use an escalation clause, it’s important to set an upper limit on how much you’re willing to pay. Otherwise, your bid will keep getting incrementally higher and you could wind up being on the hook for a final price that’s way over your budget. No one wants to pay $500,000 for a $300,000 home.
There’s no guarantee you’ll get the house
While an escalation clause is designed to keep your offer competitive, it shouldn’t be mistaken for a guarantee that the seller will accept your offer, even if it is the highest bid.
“The bottom line is with or without escalator clauses, a seller is free to accept the offer they choose to work with,” says Chris Morenza, a Re/Max agent in Miami. “In many cases, a seller sees a lower cash offer as better than a higher financed offer.”
Indeed, there’s plenty of stories of high offers being rejected for all sorts of reasons, from contingency clauses to speed of closing.
When to use an escalation clause
While all agents agree that buyers should only use an escalation clause when there is a possibility of multiple offers, it doesn’t necessarily follow that a buyer should always include an escalation clause just because the market is competitive.
“Buyers who are ambivalent about a particular house, but just want to purchase so they are no longer renting, may find themselves feeling frustrated after getting beat a few times,” says Jamie Skojec, founding principal of Home Source Realty in Northern Virginia. “But getting desperate and just offering more isn’t always the best solution.”
In that scenario, Skojec says it’s best for the buyer to keep putting out offers and save the escalation clause for a home they love.
Escalation clauses and appraisals
While an escalation clause may help you win a bidding war, it may also open a buyer up to another problem — offering more than the appraised value.
Lenders will appraise the home before extending you a loan. They’ll only lend up to a certain amount based on that appraisal.
“If you decide to offer any amount above asking price and waive the appraisal valuation, you’re going to be agreeing to purchase the home regardless of what an appraisal will come in at,” says Skojec. “If the lender’s appraisal comes in lower than the amount offered, you’re going to be paying the difference from your own funds.”
For that reason, Skojec says it’s a good idea for buyers to write an escalation clause that retains an appraisal contingency, meaning that the actual purchase price will conform to the lender’s appraisal.