What is the function of mortgage insurance?

Mortgage insurance serves a specific purpose in the lending process, primarily aimed at protecting lenders. When a borrower is unable to make a down payment of at least 20% of the home's purchase price, lenders often require mortgage insurance. This insurance provides a safety net; if the borrower defaults on their loan, the mortgage insurance compensates the lender for losses incurred from the default.

This function is crucial, especially in higher-risk lending scenarios, where the borrower may have less equity in the property. It lowers the risk to lenders, enabling them to offer loans to a broader range of borrowers, including those who might not have substantial savings for a large down payment.

In contrast, mortgage insurance does not cover the borrower's equity, offset interest rates, or cover maintenance costs of the property, as these aspects are outside the scope of its intended purpose. Understanding the role of mortgage insurance helps borrowers recognize why it may be necessary and how it impacts their loan terms.