What is the purpose of mortgage insurance?

Mortgage insurance plays a crucial role in the lending process, particularly for conventional loans that have a lower down payment. Its primary purpose is to protect the lender in the event that the borrower defaults on their mortgage payments. When a borrower does not have significant equity in the home due to a small down payment, the risk to the lender increases. Mortgage insurance mitigates this risk by providing coverage to the lender for a portion of their losses if the borrower fails to repay the loan.

This safety net encourages lenders to offer loans to individuals who may not have the traditional 20% down payment, thereby promoting greater access to homeownership. The costs associated with mortgage insurance are usually borne by the borrower in the form of premiums, which can be added to the monthly mortgage payment or paid upfront.

Other options presented do not accurately reflect the role of mortgage insurance. For instance, it does not cover the borrower's down payment, nor does it directly lower the interest rate on the mortgage. Additionally, mortgage insurance does not guarantee the loan amount for the borrower; rather, it serves as a protective measure for the lender. Understanding this function is essential for grasping the dynamics of mortgage financing and the risks associated with lending.