Who does mortgage insurance protect in case of loan default?

Mortgage insurance serves as a financial safeguard for lending institutions in the event that a borrower defaults on their loan. When a borrower fails to repay their mortgage, the lender faces potential loss of funds and the mortgage insurance mitigates this risk. By collecting premiums from borrowers, the insurance policy ensures that the lending institution can recover some or all of the outstanding loan amount in such unfortunate circumstances.

This protection is particularly significant in cases where the borrower has made a smaller down payment, as the risk to the lender is higher. Various mortgage insurance options, including private mortgage insurance (PMI) for conventional loans and FHA mortgage insurance for government-backed loans, are specifically designed to protect lenders, allowing them to offer loans with lower down payment requirements to borrowers while minimizing their own financial risk. Thus, the correct answer emphasizes the role of mortgage insurance in safeguarding the financial interests of lending institutions.