What is private mortgage insurance (PMI)?

Private mortgage insurance (PMI) is specifically designed to protect lenders in the event that a borrower defaults on their mortgage. This insurance is typically required when a borrower makes a down payment that is less than 20% of the home's purchase price. The rationale behind this requirement is that lower down payments increase the risk for lenders, and PMI serves to mitigate this risk.

When a borrower pays for PMI, it creates a safety net for the lender, providing compensation in case the borrower stops making mortgage payments. This protection makes it possible for borrowers who may not have a large sum of money saved up to still qualify for a mortgage, thereby enabling homeownership opportunities.

While the other options touch on different types of insurance, they do not align with the purpose or function of PMI. Insurance related to property damage from natural disasters addresses different risks and is not linked to mortgage default scenarios. Insurance against unemployment and coverage for closing costs also do not pertain to the lender’s protections in the context of mortgage loans. Thus, PMI is uniquely focused on bridging the gap between borrower risk and lender protection when down payments are minimal.