If bidding wars aren’t enough to turn buyers right off of the home purchase process, the introduction of an ‘escalation clause’ will definitely make matters worse. This clause is downright confusing and currently, there aren’t any rules and regulations beyond some warnings from the industry on how this clause should be used. An escalation clause is used when a buyer agrees to increase their bid by a certain amount over the highest bidder when bidding on a particular home. This amount can be capped at a certain price if the buyer chooses.
In our opinion, this clause is dangerous for many reasons:
- This increases the risk of unethical behaviour by realtors. If Agent Joe knows that buyer Paul is coming in with a $600,000 offer with an escalation clause of $5,000 over the highest bidder up to a maximum of $700,000, and if Agent Joe is extremely unethical, he could get bring in a fake offer to push buyer Paul to his maximum price.
- Due to the lack of rules surrounding this clause from The Real Estate Council of Ontario (RECO), what happens if an agent isn’t aware of the details of how to use this clause but uses it anyway? This agent might not know you can put a cap on the price. As a result, the selling agent can effectively force a buyer into purchasing a home that is likely way over his or her budget.
- What happens if two or three or more buyers use an escalation clause? This is a scary situation that would very quickly inflate the selling price of a home to each buyer’s maximum price limit (if they even set one).
- What kind of disclosure is needed to other buyers when a buyer uses an escalation clause? Again, RECO doesn’t have any set rules regarding this clause so other buyers would have no idea that this clause is in effect. Let’s say selling Agent Joe has two offers on the home – one from Buyer Paul at $550,000 using an escalation clause of increasing the price by $2,000 over the highest bidder and another from Buyer Sally at $600,000 without an escalation clause. Buyer Paul’s offer has now been increased to $602,000 and Agent Joe will likely go back to Buyer Sally and let her know that the offers are very close and ask if she’d like to improve her offer. Buyer Sally agrees to increase her offer to $625,000 and now Buyer Paul’s offer has automatically increased to $627,000. Again, Agent Joe will likely tell Buyer Sally that the offers are very close and if she really likes the home, she might decide to increase her offer again, which means Buyer Paul is going up $2,000 more over and above Sally’s improved offer. Buyers can quickly lose control within the offer process and may regret their decision.
What about sellers? You might think that this clause will benefit sellers but if buyers are pushed to their limit without having any control within the offer process, they might regret their decision and decide not to proceed with the purchase (even if they need to forego their deposit). This could leave a seller in a very difficult position. Not only is the home put back on the market but if the seller has purchased a new home, financing for this new home is likely hinging on the sale of the current home. It’s a scary position to be facing and we would never want to put a seller in a state of uncertainty that this type of situation could create.
What’s the solution? First, let’s ban escalation clauses altogether. Next, why not consider an open and transparent auction model? This method of selling your home benefits both buyers and sellers for various reasons. Buyers have full control over how high to bid and are fully aware of the offer prices of other bidders at all times. Sellers can feel confident knowing they maximized the sale price of their home without worrying about a buyer having second thoughts over the price they paid.