Simply put, a tax service fee is paid to the company that services the loan. The servicing company sets up an escrow account for the buyer and pays the buyer's taxes and homeowners insurance from that account. You're the one who puts the money in.
Now you might be thinking, "Why would the mortgage company make sure I pay my taxes? Is it because they really do care about me, like they said in the ad?" The answer is a qualified maybe. But one thing is certain: They care about themselves and what you put up as collateral, which is the house you are buying. They do it to protect the mortgage and their own interests..
Most mortgage contracts allow the lender to make tax payments on behalf of the borrower should the borrower fail to make them. If you don't make the payments, the lender can step in, make them for you and then add the amount to the mortgage with additional penalties and fees. It can also take the more aggressive step of placing a lien on your property and beginning foreclosure.
Which might raise another question. "Why would I make the payments to protect the interests of the mortgage company? Shouldn't they have to pay for that since it protects them and not me?"
Since it has been a longstanding tradition for borrowers to pay this fee, it's accepted as standard practice. You can try to negotiate the fee away but there is little chance of it happening. Remember when you were a kid and asked your father why you had to cut the lawn? The reply came, "Because I said so." If you understood that logic, you'll breeze through the settlement.
The company servicing the loan is usually an independent company that does little more than make sure the taxes are made on time. It is rarely the same institution that gave you the loan because most loans are sold on the secondary market. Even if your lending institution keeps the loan, it's a good bet that the loan's service will be handed off to another company.