What is the general function of private mortgage insurance (PMI)?

Private mortgage insurance (PMI) serves the important function of protecting the lender in the event that a borrower defaults on their mortgage. When a borrower is unable to make their mortgage payments and defaults on the loan, PMI ensures that the lender can recover a portion of the lost funds because the insurance policy will pay the lender a claim. This is particularly crucial for loans with a higher loan-to-value (LTV) ratio, typically when the borrower is making a down payment of less than 20%. By mitigating the lender's risk, PMI allows more borrowers to qualify for loans, even if they have smaller down payments.

The other options relate to aspects of mortgage financing but do not accurately capture the role of PMI. While PMI does not directly reduce the interest rate or cover closing costs, its primary purpose is to safeguard the lender's interests from potential borrower default. Similarly, while PMI may indirectly affect monthly payments by enabling the loan to close when a small down payment is made, it does not serve the specific purpose of reducing those payments.