How Escalation Clauses Work, and Why You Might Want to Use One to Buy Your First Home

When you're in the market for a home, of course, you want to get a fair price on the home of your dreams. At the same time, when the market is competitive and there are more buyers than there are sellers in your price range, you may need to be prepared to act quickly. Specifically, if you're looking to purchase a home in a seller's market, you may want to speak to your real estate agent about implementing an escalation clause as part of your offer.

What is an Escalation Clause?

Escalation clauses are becoming an increasingly common component of a written offer to a seller. Specifically, when you submit an offer with an escalation clause, you are essentially telling the seller that you're offering X amount of money, but in the event of competing offers, you're actually willing to pay Y.

For example, you may decide to put in an offer on a home for $150,000. However, you work out an escalation clause with your real estate agent that stipulates you will increase your offer in $2,000 increments up to the maximum amount of $160,000, should the seller receive other offers.

If somebody outbids your original offer by offering $151,000 for the same home, the escalation clause would automatically "kick in" and increase your offer to $152,000. This would continue as needed until you max out what you're willing to pay at $160,000. Of course, if the seller receives no better offers than yours, you will only pay as much as what you originally offered.

When to Use an Escalation Clause

Escalation clauses are a great way to provide a more competitive offer in an already-competitive market. They are especially common and may be recommended by your real estate agent in a market where you anticipate your seller is going to receive multiple offers. Furthermore, an escalation clause can help to reduce back-and-forth negotiations between buyers and sellers, saving both sides the time and hassle involved. As a result, an agreed-upon offer can be reached more efficiently and the home closing can take place more quickly.

When using an escalation clause, you'll also need to be mindful of how much you've been pre-approved for with your mortgage—as well as the current market value of your home. You probably don't want to offer more than the home is worth, especially if you cannot afford to pay the difference out-of-pocket if the home doesn't end up appraising for that much. Fortunately, an experienced real estate agent will be able to run the numbers, look at comparables in the neighborhood, and ultimately determine which course of action is best for putting together your escalation clause–often including an appraisal contingency or something similar.

Some Other Factors First-time Home Buyers Should Consider

One potential precaution to keep in mind when considering an escalation clause is that, when you submit an offer with such a clause, you lose some of your negotiation power. This is because you're essentially telling the seller up-front exactly how much you're willing to pay for the home. In a buyer's market, then, you most likely don't want to use an escalation clause because you may be better served in keeping that negotiation power to ensure you get the best deal on the home.

When you've absolutely fallen in love with a home and want to submit a competitive offer in a seller's market, an escalation clause is definitely something to consider. To learn more about escalation clauses and submitting competitive offers in today's real estate market, speak with an experienced real estate agent to get their opinion.

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Tony Gilbert is the owner of The RealFX Group. Tony specializes in real estate, real estate marketing, managing the team and achieving set goals.