Final answer:
Mortgage insurance is typically required when a borrower makes a minimum down payment on a home loan. It protects the lender from default risk and is a common requirement by banks for home loans. This requirement helps maintain stability in the insurance market by mitigating adverse selection.
Step-by-step explanation:
When a borrower makes a minimum down payment on a home loan, the type of insurance generally required is mortgage insurance. Mortgage insurance protects the lender in case the borrower defaults on the loan. This type of insurance is particularly important when the down payment is less than 20% of the home’s purchase price, as it represents a higher risk to the lender. As borrowers with low down payments are considered to be at a higher risk of defaulting, mortgage insurance premiums are used to compensate for the additional risk.
Mortgage insurance is distinct from other types of insurance, such as health insurance, which pays for medical care; car insurance, which pays for automobile accidents; house or renter's insurance, which pays for stolen possessions or items damaged by fire; and life insurance, which pays for the family if the insured individual dies. These are all important, but they serve different purposes and requirements based on specific situations.
Government intervention in insurance markets sometimes mandates the purchase of certain insurances. For example, auto insurance is legally required for car owners in most states, and homeowner's insurance is commonly required by banks when they loan funds for home purchases. These requirements are implemented to reduce adverse selection in the insurance markets, ensuring that everyone contributes to the risk pool.