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What is an Escalation Clause?
Whether you’re buying or selling a home, you may come across what is known as an escalation clause. Simply put, this practice increases your bid on a home by a specified amount whenever there is a competing bid. However as simple as it sounds, there are a lot of rules and intricacies to follow and know in order to use it correctly.
Automatically Increases a Buyer’s Home Bid
A homebuyer may find an escalation clause attractive because that means their offer will increase in the face of a competing bid on the home. An escalation clause typically works as follows:
- Mark takes into consideration the home’s original purchase price ($150,000), and his realtor adds an escalation clause to his bid.
- If there is a competing offer, Mark’s escalation clause increases his bid by increments of $1,000 over the competing bid.
- If there is no competing offer, Mark’s bid remains the same.
It’s highly recommended that homebuyers set a budget for how much they’re willing to pay for a home. If a competing buyer offers several thousand more for the home and Mark’s escalation clause brings him over his budget of $250,000, he may instead choose to back out and find a home that is within his budget. Otherwise, he may pay for a home he cannot afford and risks becoming house-poor or foreclosing at a later date.
When to Use an Escalation Clause
If the home has multiple offers on it, it may be beneficial to a homebuyer to include an escalation clause. That way, they can stay competitive on a house they love. If you want to include an escalation clause to buy a home you’re not too fond of just for the sake of buying a home, hold off until you find a home you know you want. In doing so, you’ll not only be happier with your purchase, but saving yourself a lot of frustration.
Cons of an Escalation Clause
An escalation clause doesn’t always work in everyone’s favor. In fact, some sellers refuse to accept a home offer that comes with an escalation clause because they could lose money from the lack of counter-offers.
Also, there’s the risk of bids being fabricated in order to trick buyers into paying the seller’s ceiling price. This practice is unethical, so it’s important to carefully scrutinize each offer and know when to back out, and for sellers to engage in ethical selling practices.
There’s no guarantee that the use of an escalation clause will ensure that a seller will accept a buyer’s bid. As with every large life-changing purchase like a home, work closely with a realtor and financial advisor that you can trust.