Understanding it evolved from the literal molehills helps grasp the exaggeration aspect. It's just a small error, no need to make a mountain out of a molehill.
Pro Tip 2/3
Figurative Use
It's not used for actual hills or mountains. It’s strictly a metaphor for problems. I only mentioned the issue once, don't make a mountain out of a molehill.
Pro Tip 3/3
Informal Tone
The phrase is common in casual conversation, but might not suit formal writing. You're making a mountain out of a molehill over this, let's just relax.