Back in the 2003 to 2007 real estate reign and escalation clause was not an unusual added piece of paper to the purchase and sale contract. However, over the last 10 years, this little addendum has not seen the light of day in many markets across the nation, until now.
If you've been struggling with not getting the house you want, and escalation clause may be in the works.
If you've never heard of one, and escalation clause works to help buyers pay more than the asking price in order to get the home they really want. It is a risk, however, because if the market cannot support the inflated price, the buyer may risk losing the home.
Here's how they work:
The buyer agrees to pay a certain amount for the home, however, if the homeowner or seller receives another offer that is higher than the original offer, that buyer will increase the price to a certain amount over the amount of the other offer.
I know that sounds confusing but let's give it an example. Let's say a homeowner decides to list their property for $300,000. A buyer comes in and says, okay, I agree to pay your $300,000, but, if another offer comes in, I'll be willing to pay $5000 over another higher-priced offer to $330,000. The $330,000 is the highest the buyer is willing to go, but, they are also risking the home by assuming that the property will appraise for that much if they are getting a home loan. If the buyer is paying cash it's their choice to pay over market value or not.One of the things that buyers ask is how do they know if the seller has gotten another offer? The buyer has the legal right to ask the seller to provide documentation that there is another bona fide offer. A bona fide offer is considered an offer made in good faith and is legitimate and enforceable. Sellers cannot just make up an offer.
Are there disadvantages to an escalation clause?
While there are many benefits to this type of clause in that the buyer has a good chance of getting the home they want, there can be downsides as well. For one thing, the seller now knows how much you love the home. You are kinda giving away your negotiation and your bargaining position.
Secondly, many listing agents may not be fully aware understand how an escalation clause works. If the agent doesn't understand it, chances are the seller won't either and the offer may be declined on simple lack of information.
As we mentioned before, you may have bank appraisal issues. If you're getting alone and the appraisal does not support the inflated price, the lender may reject your loan altogether unless you can come up with the difference. This means that you'll be overpaying for home compared to market value.
And then there's always the seller that just doesn't understand what you are doing and may reject it out of confusion. That can be frustrating but when you have a listing agent and a buyers agent that are communicating for the greater good of getting the home sold, getting the buyer what they want, and closing the deal, it can make a world of difference to everyone understanding the process.
Remember, the price isn't the only factor to a great offer. The terms, earnest money, timelines, and other things can play a huge factor into whether or not a seller will accept an offer. Again, it's really important to have a great buyers agent is looking out for your behalf and can write up a solid offer and also knows when to add an escalation clause and when not to.
Read More: What comes with the house?