Mortgage escalation clause is a mortgage clause that allows the lender to increase the interest rate of the loan in accordance to terms that are included in the note.
Such an escalation clause of course increases the risk of the property investment, since at some point in the future the investor will have to pay higher loan installments if such an increase takes place.
However, a property investor may be willing to accept such a mortgage escalation clause if it allows him/her to secure a lower interest rate in the initial years of the investment, and therefore lower mortgage payments, especially if a lease-up strategy is implemented. According to this value-added strategy, the investor buys a property with significant vacancy in order to increase its income through re-positioning and a well designed and effective marketing campaign.
Therefore, in the initial stages the cash-flow of the property is low due to the high vacancy rate, but it gradually increases as the re-positioning and well designed marketing strategy is implemented. Given this cash flow pattern the low mortgage payments in the early years of the investment will allow the investor to maintain a positive cash flow, while any increases in mortgage payment in the future will be covered by the higher income that the implementation of this strategy will produce.
