The tax service fee is one of a variety of closing costs, or fees assessed when a mortgage becomes official and a home sale is completed. However, the tax service fee is less a “fee” and more of an upfront, lump-sum payment of a couple of months’ worth of property taxes. The tax service fee protects lenders by keeping property taxes current during the initial months after a home purchase.
It’s important to know what different closing costs and real estate fees are, as they can add up to a significant amount. Here’s what you should know about tax service fees.
Definition and Example of a Tax Service Fee
A tax service fee is one of many closing costs you’ll pay when you finalize the purchase of a home. Tax service fees are ways for lenders to ensure there are no issues with local government entities or property taxes during the months after a sale.
“A tax service fee is a closing cost, but more of an escrow cost, meaning that you are paying this fee upfront at closing,” said Lukasz Kukwa, a real estate advisor with Coldwell Banker Realty in Westfield, New Jersey, in an email to the Balance. “[It] goes to the lender's escrow account and is drawn from at a future date to make sure that your property taxes are paid for.”
- Alternate names: Tax escrow, payments into escrow for property taxes
The amount varies based on location and lender guidelines. Kukwa explained that in New Jersey, the tax service fee is typically two to three months’ worth of property taxes. “For example, if the annual taxes for the property are $12,000, the buyer needs to bring $3,000 to closing as part of their tax escrow or tax [service] fee,” he said.
How Does a Tax Service Fee Work?
Before approving your mortgage, your lender will want to conduct a thorough assessment of the property’s tax history and upcoming bills to protect the lender’s claim to the collateral. Part of this process involves a title search, which is often handled for the lender by a title company. Kukwa said that the title search could turn up outstanding property tax bills that would need to be cleared before closing on the house can continue. Unpaid property taxes could mean the taxing government could have a right to the property, which could jeopardize the lender’s claim to it if you were to default on your loan.
Once the title company determines that there are no outstanding property taxes, it calculates how much property tax is likely to be owed in the coming months. Your lender will use that amount to assess a tax service fee that will cover the property tax bills for a short period immediately after the home purchase, such as two or three months.
After the initial period covered by the tax service fee, your mortgage payments will usually include payments into escrow, Kukwa said. The lender then will pay out these amounts on your behalf when property taxes are due.
Tax Service Fee vs. Other Closing Costs
In your closing disclosure, you may see other tax-related fees. For example, the tax monitoring fee and the tax status research fee help the lender get the information they need to charge the correct amount for property taxes, both at closing and if you include property tax in your ongoing monthly payments.
You may also be charged fees by the local government to officially change records of ownership. One example is a transfer tax, which is assessed any time a real estate transaction occurs in certain jurisdictions. Also known as documentary transfer tax, this fee can be paid by either the seller or buyer, and it’s separate from your property tax bill, even if the same government assesses both transfer and property taxes.
During closing, you may also make other upfront payments into escrow, such as homeowners association dues and homeowners insurance, Kukwa said.
“For example, some fees due at closing and required by a lender or title company often include two to three months of taxes upfront at closing, a full payment of a homeowners insurance policy, three months of homeowners association dues, and/or application fees due upfront (if applicable),” Kukwa said, as well as “any points or paying a percentage of the interest upfront to have a lower rate over the life of the loan.”
There are many kinds of fees and costs associated with your property’s title and taxes. It’s important to ask your lender about any unclear fees so you understand all costs associated with your home purchase.
- Tax service fees are one of many closing costs paid when finalizing a real estate purchase.
- The fee is a portion of the upcoming property taxes prepaid into escrow to prevent any interruption in property tax payments to the appropriate government entity.
- After the initial months covered by the tax service fee, a homeowner will either have property tax bundled into their monthly mortgage payment or be responsible for paying their property taxes separately.