What is the purpose of Private Mortgage Insurance (PMI) in a conventional loan?

Private Mortgage Insurance (PMI) serves a specific purpose in conventional loan agreements, primarily aimed at mitigating risk for the lender. When a borrower is unable to provide a substantial down payment, typically less than 20% of the home’s purchase price, lenders require PMI as a safeguard in case the borrower defaults on the loan. PMI protects the lender by covering a portion of the losses they might incur if the borrower stops making payments and the home goes into foreclosure. This insurance is especially important for lenders because it allows them to extend credit to borrowers who might otherwise be deemed too risky.

This arrangement is beneficial for borrowers as well, as it enables them to secure financing for a home without needing to save a large down payment. While PMI does come at an additional cost—often rolled into the monthly mortgage payment—it opens up opportunities for homeownership that might not be available otherwise.

Other options, such as lowering interest rates or providing tax benefits, do not align with the primary purpose of PMI; the focus is on reducing the lender's risk rather than directly benefiting the borrower in those ways. Similarly, PMI does not ensure payment delays, as it is only a protection mechanism in the event of default.