The Escalation Clause and When to Use It

Dec 31, 2020

The escalation clause is a proposal in a home purchasing contract (an offer) that can protect a buyer in case a higher offer comes in. It’s similar to contingencies in a home purchasing contract.  In principle, it’s pretty simple. An escalation clause also called an escalator, says something like “I…

Written By Offer Hut

The escalation clause is a proposal in a home purchasing contract (an offer) that can protect a buyer in case a higher offer comes in. It’s similar to contingencies in a home purchasing contract.  In principle, it’s pretty simple. An escalation clause also called an escalator, says something like “I will pay x price for the house but if the seller gets a higher offer, I will pay up to y price.”  The good news for the home seller is that they know they have multiple “offers” at a higher price and it gives them even more leverage with other buyers to try for a higher price. For the buyer, it helps lock in their purchase without paying more than they have to. Of course, like so many things legal, something that seems simple in concept can have more complexities than you first realized.

The Mechanics of the Escalation Clause

While each escalation clause is different, and each side should make sure that they understand it, they will normally have three components.

  • The initial price – From the seller’s perspective, this is the offer, at least until something better comes along and the escalator kicks in. For the buyer, this is their lowest acceptable price.
  • The Escalation Amount – Normally, the escalator will have an amount above another offer that the buyer will guarantee. For example, they might be willing to go to $2,000 above a new offer.
  • The Maximum Amount – No buyer will have an unlimited amount they will pay. Therefore, they will include a cap on their offer.

As an example, the buyer may offer $200,000 with a $2,000 escalation amount up to a maximum of $220,000. This means that if no other offers come in, the buyer will pay $200,000. However, if an offer comes in for $210,000 then the buyer will pay $212,000 ($210,000 plus the $2,000 escalation amount). Like we said, each clause and negotiation will be different so both sides need to make sure they are clear and aligned on the terms to avoid any issues down the road.

Deciding on An Escalation Clause

Using an escalation clause in an offer, or accepting one for the seller can have benefits or disadvantages for each.  The pros and cons vary based on the situations and what the buyer or seller thinks is likely to happen. It can protect either side or obligate them to something they may not want later on.  They each need to think about that during the negotiations.

The Seller

Just like any other offer, the seller isn’t obligated to accept an escalation clause. They need to consider their market, other opportunities, and timing. Of course, if there aren’t other offers and aren’t likely to be then a seller might want to accept an offer with an escalation clause.

A seller may not want to accept an escalator because they think they have better options with a traditional bidding war. They may be looking to incentivize buyers to make their best offers out of the gate.

These clauses also add some complexity to the deal and the paperwork. A seller may want an attorney to review the specifics. These aren’t all that common and if your realtor isn’t knowledgeable in the, or it has unique terms, then the realtor may not be able to help.

There are strategies involved in these for both sides.

The Buyer

For a buyer, these are mostly upside as they can guarantee a lower price with less risk of losing the house. At the same time, if a seller is skittish an escalation clause could make negotiations more complicated or prolonged. During that time, the seller could get other offers or decide not to take it. A seller may also need an attorney to draft the best language to protect them.

These offers also lay out all your cards at once for the buyer and the buyer needs to consider what they are giving up. They tell right away what you are willing to pay. For the buyer, the opportunity for such a condition is when the buyer thinks there will be multiple offers.  A good realtor should be able to help negotiate without these though such a clause does lock your offer into a contract without the back and forth of a negotiation when the seller could take any other offer.

Using the Escalator in Negotiations

These clauses can complicate discussions but there are reasons to consider them for both sides of the home sale.  They provide a tool in your negotiating toolbox. Like any tool, they aren’t perfect in every situation but they have their place.  They might be worth considering when you make an offer or accepting an offer.

 

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