What is PMI and when is it required?

Private Mortgage Insurance, or PMI, is specifically designed to protect lenders in the event that a borrower defaults on a loan. It is generally required when the borrower makes a down payment of less than 20% of the home's purchase price. The rationale behind this requirement is that a lower down payment indicates a higher risk for the lender, as the borrower has less equity in the home. PMI mitigates that risk by ensuring that the lender can recover a portion of their losses if the borrower is unable to repay the loan.

To elaborate, when a borrower opts for a loan with a down payment lower than 20%, the lender typically requires PMI to cover the gap. This insurance is added as a monthly cost on top of the borrower's mortgage payment, making homeownership more accessible for those who cannot afford a larger down payment right away. Ultimately, PMI serves as a tool to facilitate lending while protecting lenders from potential financial losses.

The other options do not accurately describe PMI; they either misstate what the insurance is meant for, or incorrectly categorize the type of mortgage insurance relevant to borrower situations.