What is a Tax Service Fee?

A tax service fee is paid by mortgage borrowers to mortgage lenders to ensure that a mortgaged property's property taxes are paid on time.

How Does a Tax Service Fee Work?

For example, let's assume that John buys a house. He borrows $100,000 from Bank XYZ to make the purchase. The city John lives in assesses the property and sends John a $500 property tax bill every year.

Because the house is Bank XYZ's collateral, Bank XYZ wants to make sure that nobody else is able to lay claim to the house -- including the city -- if John doesn't make his payments. To protect its collateral, Bank XYZ hires a tax service agency to monitor the property tax payments on John's house. If John misses a payment or makes a late payment, the tax service agency alerts Bank XYZ. The bank passes along this monitoring expense to John via a tax service fee at closing (or, sometimes, as a fee included as part of his monthly escrow payment).

If John doesn't want to pay the fee, he could set up an impound account, which is an account with Bank XYZ into which he pays a little each month toward the property tax bill (which the lender then sends in to make the tax payment).

Why Does a Tax Service Fee Matter?

Tax service fees exist because lenders want to protect their access to collateral if a borrower defaults. After all, if a borrower isn't paying his property taxes, it's probably only a matter of time before he stops paying his mortgage.

Having tax service agencies involved with a property can benefit buyers as well as owners. If the previous owner of a piece of property owes back taxes on it, the tax authority has the power to step in and seize property, even if a bank has a lien on the property as well. In this case, the tax service agency can help ensure that a buyer is purchasing a property free and clear of any property tax encumbrances.