Nationwide Mortgage Licensing System (NMLS) Practice Exam

What is the primary purpose of mortgage insurance for FHA loans?

1. To protect lenders against borrower default

2. To lower interest rates

3. To allow for larger loan amounts

4. To ensure property value maintenance

The correct answer is: To protect lenders against borrower default

The primary purpose of mortgage insurance for FHA loans is to protect lenders against borrower default. This form of insurance plays a crucial role in the FHA loan program, which is designed to help low to moderate-income borrowers who may not have substantial savings or a strong credit history. By requiring borrowers to pay mortgage insurance premiums, the Federal Housing Administration (FHA) provides a safety net for lenders. In the event of borrower default, the mortgage insurance compensates the lender for a portion of the loss, thereby reducing the financial risk associated with lending to borrowers who may present a higher likelihood of default. This mechanism enables lenders to offer more favorable terms, such as lower down payments and more lenient credit requirements, making homeownership accessible to a larger segment of the population. Other aspects such as lowering interest rates, allowing for larger loan amounts, or ensuring property value maintenance are not the primary functions of FHA mortgage insurance. While these effects may indirectly occur due to the availability of mortgage insurance, they do not encompass its main goal, which is focused on safeguarding lenders' investments.