When you borrow the money to buy a home from a lender, part of the closing settlement costs may include a year's worth of escrow. This is a device to protect the lender, an assurance that the first year's property taxes and homeowner's liability insurance on the new home purchase are made. In fact, some lenders will only make loans contingent upon collecting escrow monies, particularly to low income or first time home buyers.

Why? There are two reasons. Not only does escrow money protect the lender, it gives the lender interest free money to invest. The escrow money doesn't just sit in an account like a savings account - it exists only on paper. Lenders use the money, keep track of it, and then use the return on investment to resupply the borrower's escrow account when tax or insurance payments are due.

The caveat is that you, the borrower, don't make any interest on the money - the lender does. All the lender does for you is hold the money for you without giving you the benefit of interest accumulated or the return on investment. And sometimes, they don't even do that much.

An escrow account with your lender can seem like a wonderful convenience. Every month when you make your loan payment, you pay extra to have your lender take care of paying your property taxes, which can total approximately 2 to 3 percent of your purchase price. Instead of facing a big tax bill at the end of the year, your taxes are paid by the lender. But what if they aren't? What if your lender forgot? Or worse, what if your lender incurred a penalty from the property tax levying body and billed the penalty to your account?

Believe it or not, it happens - so frequently that the federal government has stepped in to help rectify the problem.

The Real Estate Settlement Procedures Act (RESPA) is a consumer protection statute provided by the U.S. Department of Housing and Urban Development (HUD,) an organization devoted to fair housing for all citizens.

Among its many jobs, this watchdog of the government is currently growling at lenders who accidentally or routinely fail to make tax payments on time for their borrowers. RESPA's guideline is simple - if the home owner is current with his/her mortgage payments, then the escrow payments should be current also.

But what if the lender wasn't on time? Whose fault is it? Lenders are different, some receive information from the taxing authority and some require that the tax bills are forwarded by the home owner. If the home owner doesn't do so in a timely fashion, the door is open to dispute.

According to RESPA, your lender must send you an Annual Escrow Account Statement (AEAS.) It is your job, however, to compare your AEAS with your tax bill. If you did not receive a bill from your county, city, or other taxing authority, again, it is your job to ask the taxing authority what you owe. Then, you must check to make sure that the amount the lender paid from your escrow account matches your tax bill. If the amount the lender paid from your escrow account is more than your tax bill, that difference may be a penalty or late fee.

Do you deserve to pay the late fee or the lender? That can only be resolved by a written request to your lender to waive the penalty. RESPA even a provides a sample complaint letter for you to use.

Another scenario that can hurt your escrow account is something your lender has no control over and that is the fact that sometimes your property tax rate changes. Your city council may have voted to bring the Olympics to your town, or there may have been a relocation boom with rising property values on which the city wishes to cash in. For whatever reason, it is unlikely that your current property tax rate is written in stone. Count on it to change sooner or later.

Should your property tax rate increase, the escrow account you have established with your lender may not hold enough to cover the taxes. Typically what the lender will do is pay the tax deficit and raise your escrow account payment to cover the new tax assessment plus the deficit. Then the fixed rate mortgage you thought would be the same, safe amount every month is suddenly $100 to $200 or more per month. On a $100,000 note, that could mean as much as a 22 percent increase in your monthly payment.

But you will have plenty of warning should this event happen. Your tax levying body should notify you of any tax increase six to nine months in advance. You will receive in the mail a notice of what the new assessment will be. If you have a dispute about the new rate, there will be directions on how to contest the assessment.

If an assessment reduction is unlikely, and you can bet that it will be, you will have plenty of time to take appropriate action. You can notify the lender yourself and arrange for additional payments or you can sock the money away in your own account to have on hand when the taxes come due.

If you are financially responsible and would like to make interest on your escrow money yourself, talk to your lender and ask what requirements the organization would have in order to allow you to pay your own property taxes. If you can make the payments on your home, you can as easily set aside the amount you will need for taxes and put it in a money market interest bearing account until the taxes are due. Then, if you are surprised by a property tax increase, the interest you have earned will help cover the shortfall.

So stay current with your payments, stay on top of your taxing authority and its assessments, and compare your records with the lender's.