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KASS: Should house offer include escalation clause?

Q:     My wife and I are house-hunting. A real estate agent friend told us that the market is hot, and there are very few houses available for a large number of potential buyers. We were advised to consider including an escalation clause in any contract we present to a seller. And if there is an escalation clause, how do we deal with the amount of the loan we plan to get? It was also suggested that we decline having a home inspection. What do you think about these issues? – Alvin

A:     Maybe for the first and absolutely no for the second.

Let’s look at the inspection contingency. Unless you are a professional engineer or architect, what do you know about houses? Is the electricity up to code? Does the HVAC system work? Are the joists that seem to be holding up the basement ceiling adequate (true story)? You are investing in what may be the biggest purchase of your life; don’t take a chance that something – possibly major – will occur soon after you take title. If a seller is not willing to let you have 10-12 days after signing the sales contract to have a professional inspector carefully go over every detail in the property, my advice is to go somewhere else.

I write from experience with some clients, who wanted an expensive house but the seller was not willing to allow a brief inspection period. Against my strong advice, they bought the house without the inspection. Four months later, they called to tell me they should have listened to me; they had serious roof damage which cost them almost $100,000 to correct. Fortunately, they could afford it. And there was no insurance coverage either.

What about the escalation clause? Let’s look at this example. In my experience, in most parts of the country, the potential buyer makes an offer, and the seller has three alternatives: accept, reject or counter-offer. You put in an offer of $450,000. The seller gets another offer with similar terms but with the price of $452,000. Sorry, you lose.

How do you try to protect yourself? You include in the offer a statement that you will pay $1,000 more than the highest offer, subject however to a cap of $456,000.

When advised that the other offer is $452,000, your escalation clause bumps the contract price up to $453,000 and you will be the winner. But there are important provisions to be included in your escalation. You want proof there is a real offer at the highest price. I have been involved in a case where an unscrupulous agent indicated – falsely – there was a higher offer, and my client –without seeing any evidence – increased the offer by $5,000. You should review a copy of the other offer; the name and other personal information of that buyer can be removed.

Incidentally, the agent involved in my case paid my client $5,000 plus my legal fees. So when you are about to sign a real estate contract (or any contract for that matter) try to insert the following language: “The prevailing party in any litigation or arbitration shall be awarded reasonable attorney fees and court costs.”

If you submit the escalation clause, how do you handle the amount of the mortgage loan you plan to get? Typically, your contract offer states you will get a loan of 20 percent – or 10 percent or even 3 percent –of the purchase price. If the original offer is increased, there are three ways to deal with the loan. First, you can pay the difference in cash, and there is no need to change the terms in the contract. Alternatively, you can change the loan amount in the contract to reflect the new price. Or you can partially increase the loan amount and pay the difference in cash.

Bottom line: I am not a fan of escalation clauses, but if this is really your dream house, make sure you include the necessary protections discussed above. And most real estate agents should have a form escalation clause which includes these protections.

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