What is an escalation clause, and can it help you win a bidding war?

The real estate market remains hot, even in the face of rising mortgage rates and limited inventory, and buyers are still frequently facing bidding wars. To lessen the anxiety, homebuyers can add an escalation clause to an offer. This tactic might help you snag the home by incrementally raising your bid as others come in. But if you choose to go this route, it’s smart to tread cautiously and know what you are signing up for.

What is an escalation clause?

An escalation clause is designed to edge out competing bids by automatically raising an offer when a competing bid comes in. It’s also known as an escalator clause. Think of it like setting your maximum bid on eBay.

“An escalation clause is when a buyer is willing to go over the highest offer, up to a specified amount,” says Kristine Halverson, a Realtor with Compass in Santa Monica, California.

The clause is triggered by a competing offer from another potential buyer. When that competing bid is made, the escalation clause automatically increases its own offer by a preset amount. A clause may or may not limit, or cap, the buyer’s maximum bid.

For the clause to be triggered, sellers need to prove there was another bona fide offer, Halverson says. Sellers or their agents sometimes resist using the clause, but she says they’re usually a pretty effective tool when multiple bids are likely.

How does an escalation clause work?

An escalation clause is submitted as an addendum to your offer specifying that if there are multiple bids your bid will increase up to a set amount. Typically, a copy of a competing offer serves as the proof needed to trigger the clause. But in practice, some agents say that kind of proof can be problematic.

One reason is that there’s room for misinterpreting the buyer’s intentions. “Sometimes a competing offer may be for a price — say (the seller wants) $300,000 — but also (includes) $10,000 in buyer closing costs paid by the seller, so in effect, it’s $290,000,” says Rob Levy, principal broker with Keller Williams Realty Professionals in Portland, Oregon. “But the other buyer’s actual written offer is for $300,000, so the escalation can be interpreted as $310,000.”

Kaki Lybbert, a Realtor with Century 21 in Denton, Texas, and the National Association of Realtors’ vice president of advocacy, says it’s possible for offers to be fabricated to trigger the clause. “I don’t like them,” she says. “I think they’re not fair, I think they have risks on both sides.”

In fact, escalation clauses have been restricted by the Texas Real Estate Commission since 2016. Because they are much more complex than a standard offer, buyers in Texas are strongly advised not to use them. Those who choose to must do so through an attorney, not a Realtor.

If you do choose to use an escalation clause, it’s important to set an upper limit on how much you’re willing to pay. Otherwise, your bid will keep getting incrementally higher and you could wind up being on the hook for a final price that’s way over your budget. No one wants to pay $500,000 for a $300,000 home. For greater protection, tie it to the financing contingency if possible.

There’s no guarantee you’ll get the house

While an escalation clause is designed to keep your offer competitive, it shouldn’t be mistaken for a guarantee that the seller will accept your offer, even if it is the highest bid.

“The bottom line is, with or without escalator clauses, a seller is free to accept the offer they choose,” says Chris Morenza, a real estate agent with Florida One Realty in Miami. “In many cases, a seller sees a lower cash offer as better than a higher financed offer.”

When to use an escalation clause

All agents agree that buyers should only use an escalation clause when there is a possibility of multiple offers. However, it doesn’t necessarily follow that a buyer should always include an escalation clause just because the market is competitive.

“Buyers who are ambivalent about a particular house, but just want to purchase so they are no longer renting, may find themselves feeling frustrated after getting beat a few times,” says Jamie Skojec, founding principal of Home Source Realty in northern Virginia. “But getting desperate and just offering more isn’t always the best solution.”

In that scenario, Skojec says it’s best for the buyer to keep putting out offers and save the escalation clause for a home they really love.

If the right home is in high demand, make sure your offer is actually competing against other financed offers (instead of all-cash), or vice versa.

Another tactic to consider: a time-limited offer with a non-disclosure clause. This means that the offer can’t be disclosed to other agents, brokers or buyers, and it expires within a short time frame, usually 24 hours or less.

Escalation clauses and appraisals

While an escalation clause may help you win a bidding war, keep in mind that it may also open a buyer up to another problem — offering more than the home’s appraised value.

Lenders will appraise the home before extending you a loan. They’ll only lend up to a certain amount based on that appraisal.

“If you decide to offer any amount above asking price and waive the appraisal valuation, you’re going to be agreeing to purchase the home regardless of what an appraisal will come in at,” says Skojec. “If the lender’s appraisal comes in lower than the amount offered, you’re going to be paying the difference from your own funds.”

For that reason, Skojec says it’s a good idea for buyers to write an escalation clause that retains an appraisal contingency, meaning that the actual purchase price will conform to the lender’s appraisal.