What Is an Escalation Clause?

Quick Answer

An escalation clause is a part of your purchase offer stating that, if there is a competing offer on the home, your offer price will rise in pre-set increments up to a set maximum offer. It can help you win a bidding war with other buyers.

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Although rising mortgage interest rates, inflation and recession worries have slowed U.S. home sales slightly, it's still a seller's housing market. Nearly half (47.3%) of homes sold in July 2022 commanded more than the listing price, according to data from Redfin. This high competition makes it more difficult to secure a home without engaging in a bidding war.

In real estate, an escalation clause or "escalator" states that, if there are competing offers, your offer price will automatically rise in designated increments, up to a maximum amount you set. Using an escalation clause during the homebuying process could help you outbid others, but knowing the ins and outs is crucial to make sure you don't get burned. Learn how escalation clauses work, when you might want to use one and their pros and cons.

What Is an Escalation Clause?

An escalation clause is wording in your purchase offer stating that, if there is another offer on the home, your offer price will escalate in pre-set increments up to a ceiling you choose. Using an escalation clause, you can automatically increase your offer and potentially outbid the other buyer while still staying within your home purchase budget.

How Does an Escalation Clause Work?

An escalation clause generally has three elements:

  1. Your initial offer price
  2. The increments in which your offer price escalates if there is a competing, higher offer (escalation clauses do not kick in unless another buyer makes an offer)
  3. The maximum price you're willing to pay

Here's how an escalation clause might play out:

Buyer A makes an offer of $300,000 on a home and includes an escalation clause. The escalation clause states that, in the case of competing offers, Buyer A's offer will increase in increments of $3,000 above the other offer. Buyer A sets a cap of $321,000.

Buyer B makes an offer of $301,000 for the same home. This triggers Buyer A's escalation clause, and Buyer A automatically counter-offers $304,000 ($301,000 plus the $3,000 escalation). If Buyer B comes back with a counteroffer of $309,000, Buyer A's offer escalates to $312,000 ($309,000 plus the $3,000 escalation), and so on. If Buyer B's offer surpasses Buyer A's ceiling of $321,000, Buyer A stops making counteroffers.

Pros and Cons of Escalation Clauses

Escalation clauses have their benefits and downsides for both buyers and sellers.

Pros for buyers:

  • Can differentiate you from other buyers, which is important in a seller's market
  • Eliminates emotion from the negotiation process so you don't get caught up in excitement and overpay for the home
  • Can speed up the purchase process by automating offers and counteroffers

Cons for buyers:

  • Shows the seller upfront how much you're willing to pay
  • Seller could make a counteroffer asking other bidders to meet or surpass your highest price
  • Eliminates ability to negotiate price with seller

Pros for sellers

  • Can demonstrate the buyer is serious about the purchase
  • Can speed up the purchase by streamlining the process of offers and counteroffers

Cons for sellers

  • Might lead to lower initial offers
  • Price may not be seller's biggest concern

When to Use an Escalation Clause

Escalation clauses can be useful tools in real estate, but they aren't ideal for every situation. Consider using an escalation clause when:

  • It's a seller's market in which multiple offers are standard. If you expect to end up in a bidding war, an escalation clause can keep you from getting caught up in the excitement and offering more than your budget. Choosing the increments and cap you're comfortable with ahead of time helps keep emotion out of the process.
  • You've found your dream house and don't want to lose it. An escalation clause can help demonstrate your commitment to purchasing the home.
  • You want to speed up the negotiation process. Instead of you, your real estate agent, the seller and their agent going back and forth about offers and counteroffers, escalation clauses automate the process.

An escalation clause can sometimes lead to bidding more than a home is worth. This can torpedo the purchase because banks typically don't make mortgage loans for more than a home's appraised value. Suppose a buyer offers $300,000 and the seller accepts the offer, but an appraisal values the home at $280,000. The bank may approve a mortgage loan for $280,000, but the buyer will have to make up the additional $20,000 in cash, which they may not be able to do. Buyers can avoid this risk by including an appraisal contingency in the offer.

Some sellers don't accept offers that have escalation clauses. Escalation clauses allow buyers to start with a lowball offer and only raise it if other bids come in. Sellers may prefer to have buyers make their best offer from the outset in hopes of getting a higher price.

Keep in mind that getting the highest selling price isn't the only consideration for some sellers. For instance, a seller whose job has transferred him out of state may prioritize a quick closing over a higher price. Some sellers may prefer offers without contingencies to streamline the sale. An all-cash offer for $280,000 that can be completed quickly may be more desirable than a $300,000 offer from a buyer who needs to finance the purchase.

Get Your Credit in Shape for House Hunting

Including an escalation clause in your offer isn't the only way to get a home seller's attention. Other ways to sweeten the deal include making a bigger down payment and getting preapproved for a mortgage—not just prequalified. Preapproval shows the seller you're serious about the purchase and ready to move ahead quickly if your offer is accepted.

Before you start house hunting, take some time to get your credit ready for a mortgage. Check your credit report and credit score, pay down debt and avoid applying for new credit in the months before shopping for a home. Having a good credit score can help you qualify for favorable mortgage terms and make it easier to afford the home of your dreams.

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