What does an Escalation clause mean?

In this market with very tight inventory and multiple offers, if you are shopping for a property, you might be faced with a tough decision when it comes to the price you offer. Of course, the offer isn’t just about price; there are a number of other terms that can be adjusted to benefit the seller but coming in with a strong offer price is usually a very important component.

Oftentimes if you make an offer within the first few days of the listing going live, you may not know if you are competing with one other offer, twenty other offers, or if it is just yourself. In cases like this, it might make sense to include an escalation clause, or additional terms that adjust the price upwards to beat the highest price by $x amount, not to exceed $x dollars.

For example, let’s say a house is on the market for $395,000 and you decide to offer above the asking price by offering $410,000. But you don’t want to miss out if someone offers $412,000. What you can do is hedge your bet by only committing to more than $410,000 if someone else does. This is done via an escalation clause. In this example, say you are willing to go up to $420,000. Your escalation clause might then indicate you are willing to beat the highest offer price by $500 but that the final price won’t exceed $420,000.

We like to tell people that whatever number they go up to, they need to be able to sleep at night if they get the house or don’t get the house. If there will be any regrets in either scenario, the number you choose may not be the right one. A home is worth what someone is willing to pay for it. For you, that is a question only you have the answer to.

It can be tough to know where that sweet spot is and often decisions have to be made quickly. If you are faced with having to increase the price by $5,000, $10,000, or $20,000, you should know what that means for your resulting monthly payment in addition to your total outlay. Below is a table that illustrates the additional monthly payment at $5,000 increments up to $50,000 at a number of interest rates for a 30-year fixed rate mortgage. These include principal and interest only.

4.0% 4.5% 5.0% 5.5% 6.0%
$5,000 $23.87 $25.33 $26.84 $28.39 $29.98
$10,000 $47.74 $50.67 $53.68 $56.78 $59.96
$15,000 $71.61 $76.00 $80.52 $85.17 $89.93
$20,000 $95.48 $101.34 $107.36 $113.56 $119.91
$25,000 $119.35 $126.67 $134.21 $141.95 $149.89
$30,000 $143.22 $152.01 $161.05 $170.34 $179.87
$35,000 $167.10 $177.34 $187.89 $198.73 $209.84
$40,000 $190.97 $202.67 $214.73 $227.12 $239.82
$45,000 $214.84 $228.01 $241.57 $255.51 $269.80
$50,000 $238.71 $253.34 $268.41 $283.89 $299.78

 

Of course, you should make sure that whatever your offer price, it is within your financial comfort zone – and the banks! It is important to look at what the escalation clause will mean for your short-term and long-term goals and also realize that it is a means to an end – the end being your new home.

Escalation clauses don’t need to be scary. When you are ready to buy, I will work with you to make sure that your offer is consistent with your goals. Let’s talk!

Leave a Reply

Your email address will not be published. Required fields are marked *