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.

Escalation clauses automatically increases a buyer’s home bidSmartMortgage

As a homebuyer, you may find an escalation clause attractive because that means your offer will increase in the face of a competing bid on the home. An escalation clause typically works as follows:

  • You take into consideration the home’s original purchase price ($250,000), and your realtor adds an escalation clause to the bid.
  • If there is a competing offer, your escalation clause increases your bid by increments of $1,000 (or other amount of your choice) over the competing bid.
  • If there is no competing offer, your bid remains the same.

Set a budget of how much you can realistically afford. If a competing buyer offers several thousand more for the home and your escalation clause brings you over your budget of $300,000, you may instead choose to back out.

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 can keep you in the  competition without delay.

Use escalation clauses with caution

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 the ability to issue a counteroffer.  If you do include an escalation clause, it is essential that you can honor it. Make sure you are pre-approved for the max amount that you are willing to pay for the home and that is the ceiling of your clause.

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 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.

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The above information is for educational purposes only. All information, loan programs and interest rates are subject to change without notice. All loans subject to underwriter approval. Terms and conditions apply. Always consult an accountant or tax advisor for full eligibility requirements on tax deduction.