Is this a legitimate way to avoid PMI?

Dear Dr. Don,
We are in the process of buying a second home but don't have enough to put down to get out of the PMI (private mortgage insurance). Our loan officer is trying to convince us to split the loan into two mortgages. The first would be the majority of the loan and the second mortgage would be tax deductible and would help us avoid the PMI. Overall the monthly payment would be $50 to $60 cheaper.

Is there a downfall to this, and why don't you hear more about this? It seems shady, but then again we don't buy houses everyday, so how would we hear about it? Thanks. -- Shanna Surreptitious

Dear Shanna,
Homeowners hate paying private mortgage insurance (PMI) so they look for ways to structure the financing to avoid paying the insurance. As long as the first mortgage is 80 percent or less of the home's appraised or market value, the first mortgage lender won't require PMI.

An 80-10-10 loan has a first mortgage with an 80 percent loan-to-value, a second mortgage for 10 percent of the home's market value, and a 10 percent down payment paid by the buyer. There are other variants of this type of loan, but the key component is that the first mortgage is small enough that it doesn't require PMI.

PMI isn't forever. The Homeowner's Protection Act of 1998 requires mortgage lenders to cancel the PMI when the loan-to-value falls below 78 percent of the home's original value. Homeowners can petition the lender to cancel the policy sooner if they've realized sufficient appreciation on the property that the loan-to-value is 80 percent or less of the home's appraised value.

Make sure you understand the terms of both loans. Telling me that the combined mortgage loans are $50 to $60 cheaper per month doesn't mean much if the second mortgage is interest-only over the first 10 years.

Another way to avoid PMI is to use a self-insured mortgage. The interest rate is higher than for a conventional mortgage, but if you can use the interest deduction on your tax returns, the after-tax cost could be less than either the first mortgage with PMI or the 80-10-10 loans.