Private mortgage insurance (PMI) adds hundreds or even thousands of dollars a year to mortgage payments, so it’s logical to wonder whether there’s any way to avoid paying it.

The best way to avoid PMI is to make a down payment of 20 percent on a home loan. Private mortgage insurance helps the lender recover its money if the buyer defaults on the loan. When lenders have been paid 20 percent of a home’s original value, they are more likely to recoup their costs if they have to foreclose.

Even federally insured loans, such as Veterans Administration (VA) loans or Federal Housing Authority (FHA) loans, often require a type of mortgage insurance commonly referred to as MMI.

Therefore, if you can not make a 20 percent down payment, you probably will have to get private mortgage insurance.

How it works
Your lender will obtain the insurance for you, and you can roll the private mortgage insurance payments into your monthly mortgage payments.

You can ask to have PMI canceled once you have 20 percent equity in the home -- in other words, when you have paid down 20 percent of the purchase price of the home. Private mortgage insurance should automatically be canceled once you have achieved 22 percent equity.

Avoid PMI with a piggyback loan
There is another way to avoid private mortgage insurance -- a piggyback loan. Here’s how it works: When you get your mortgage loan, you also take out a second, smaller loan for the difference between your down payment and a 20 percent down payment. You use the piggyback loan to pay the rest of your down payment.

Also called 80-10-10 loans, piggyback loans can be a smart alternative to PMI. Even though you are paying off two loans, the monthly payment for the piggyback loan could be smaller than monthly payments for private mortgage insurance. In addition, the interest on the piggyback loan may be tax-deductible. In the past, private mortgage insurance payments were not tax-deductible. For the year 2007, however, PMI on new mortgages can be deducted for individuals who have annual adjusted gross income of $50,000 or less or for married couples with an adjusted gross income of $100,000 or less.

Talk to a qualified financial specialist to see what option might be best for you.