Q: We are seeking a mortgage loan, and are prepared to make a 20 percent down payment on the purchase price. All of the lenders we are talking to have agreed that we will not have to pay private mortgage insurance, but all are requiring that we escrow money for taxes and insurance. Is this really necessary, and why do lenders require these escrows?

A: I receive a large number of questions about escrows for taxes and insurance and will attempt to highlight what lenders can and cannot do in this area. State laws differ, and you should check with your own attorney to determine what your local law permits.

The theory behind the escrow makes sense. Lenders are concerned that if you do not pay your annual real estate taxes or your annual insurance premium, the lender's security will be affected.

While the theory makes sense, though, in my opinion the primary reason the lenders have for wanting these escrow accounts is that, month by month, they accumulate huge sums of money that they can use for their own benefit, without paying interest to the consumer. Not only do lenders not pay interest on these escrowed funds, but most lenders charge the borrower at settlement a one-time "set-up" fee, ranging from $60 to $75, to establish this escrow arrangement.

In its legal setting, the word "escrow" means to put something--such as a deed or money--in the care of a third party until certain conditions are met. In the mortgage arena, the lender collects, on a monthly basis, one-twelfth of the annual real estate tax bill and the annual hazard insurance premium. When the tax or insurance bill comes due, the lender takes those escrowed funds and makes the required payment.

Many years ago, Congress adopted the Real Estate Settlement Procedures Act, which includes the regulation of these escrow accounts. Because of major consumer objections and concerns, Congress amended the act in 1990 and also imposed strict reporting requirements on lenders.

This law applies to all "federally related mortgage loans." It is a very broad category, and includes loans secured by a first lien--deed of trust or mortgage--on residential real property, including condominiums and cooperatives, that are either insured or guaranteed by a governmental agency such as the Federal Housing Administration or the Veterans Administration, or that are intended to be sold by the originating lender to such secondary mortgage markets as Fannie Mae or the Federal Home Loan Mortgage Corp. (Freddie Mac).

Under the law--unless local law requires otherwise--at the initial settlement, a lender has the right to require a borrower to deposit in escrow for the payment of taxes or insurance a sum not to exceed the amount of these actual charges, plus one-sixth of the estimated total amount of these taxes or insurance premiums.

If the taxes come due in January and you are settling in August, your first month's payment will not be due until October. In October, November and December you will make three months' worth of escrow payments. But since the lender will require a full year's payment in January, it has the right to escrow nine months at settlement, plus one-sixth of the total amount (in other words, an additional two months' worth of escrow).

Basically, the same rules apply for escrow requirements after the settlement takes place on a continuing yearly basis. In other words, the lender has the right to hold two additional months' escrow, on the theory that if you are delinquent in one or two of your monthly payments, the lender will still have sufficient funds by tapping into this two months' surplus.

On an annual basis, the lender who services your loan must send you a statement clearly itemizing "the amount of the borrower's current monthly payment, the portion of the monthly payment being placed in the escrow account, the total amount paid into the escrow account during the period, the total amount paid out of the escrow account during the period for taxes, insurance premiums . . . (as separately identified) and the balance in the escrow account at the conclusion of the period."

This statement must be submitted to each borrower not less than once a year.

Once you receive the annual statement, you must review it carefully. Confirm with your taxing authority and with your insurance company exactly when the payment is due, and the amount of that payment. Sit down with a calculator and determine whether the lender has properly calculated the amount of the escrow. Congressional testimony has uncovered many errors made by mortgage lenders, some in favor of the borrower and others in favor of the lender.

Additionally, I have seen far too many cases where lenders inadvertently do not make the required real estate tax payment on time--or at all. Often, the first time that the homeowner learns of this nonpayment is when he or she receives a notice of tax sale from the jurisdiction where there property is located.

Accordingly, I strongly suggest that every homeowner who is required to escrow for taxes and insurance write his lender--once a year--demanding proof of payment of his real estate tax and insurance premium. If the lender does not respond promptly, the homeowner should contact the appropriate tax authority to confirm payment of these taxes. But also complain about the lack of response to your state or local financial regulatory authority.

D.C. residents should keep in mind that if they have 20 percent or more equity in their property (i.e., if they borrow or refinance 80 percent or less than the value of the property), they have the absolute right to pay their own taxes and insurance without escrow--and should receive a notice from the lender to that effect. Some lenders try to increase the mortgage rate when the borrower opts to avoid escrow. In my opinion, this is not legal and should be contested.

Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address.