In today's real estate market, lack of a down payment discourages many would-be home buyers.

Most home buyers don't have large cash reserves and will want to make as low a down payment as possible. Luckily it's often possible to buy a house -- especially a starter house -- for a modest down payment. But most buyers will have to put down between 5%-20% of the home's purchase price, unless they qualify for a zero or low down payment plan.

If you haven't already saved up thousands of dollars, here are some ways to raise the needed funds.

Borrowing From Your 401(k) Plan

An excellent source of down payment money is a loan against your 401(k) plan. Check with your employer or the plan administrator to see whether your plan allows for loans. If it does, the maximum loan amount under the law is the lesser of one-half of your vested balance in the plan or $50,000 (unless you have less than $20,000 in the account, in which case you can borrow the amount of your vested balance, but no more than $10,000). Other conditions -- including the maximum term, the minimum loan amount, the interest rate, and applicable loan fees -- are set by your employer. Any loan must be repaid, with interest, in a "reasonable amount of time," although the Tax Code doesn't define "reasonable."

Be sure to find out what happens if you leave the company before fully repaying a loan from your 401(k) plan. If the loan would become due immediately upon your departure, income tax and penalties may apply to the outstanding balance. But you may be able to avoid all this hassle by repaying the loan before you leave.

Tapping Into Your IRA

You can withdraw up to $10,000 penalty-free from an individual retirement account (IRA) for a down payment to purchase your first principal residence. (However, you may have to pay income tax on the withdrawal, and you might have less time than you'd like within which to return it to the IRA if you decide not to use it.)

This $10,000 is a lifetime limit -- and it must be used within 120 days of the date you receive it.

The law defines a first-time homeowner as someone who hasn't owned a house for the past two years. If a couple is buying a home, both must be first-time homeowners. Ask your tax accountant for more information, or contact the IRS at 800-829-1040 or see its website at http://www.irs.gov.

Using a Gift to Help With the Down Payment

Often parents and grandparents will help when it comes to buying a house. If you're fortunate enough to receive a gift of part or all of the money you need for a down payment, great. Your monthly payments will be lower, and the amount of house you can afford will be higher, than if you borrowed the down payment. As a practical matter, the gift is going to have to come from a close family member -- the lender involved in the rest of the deal won't trust that gifts from distant family members or friends are not secret loans.

Gifts up to $12,000 per year per person (in 2006) can be given gift tax-free. This means, for example, that every year your mother and father can give you and your spouse $48,000 in total without having to file a gift tax return. They should, however, give you a letter or other written document stating that the money is indeed a gift with no expectation of repayment.

Borrowing Down Payment Money From a Relative or Friend

Another way to raise money for a down payment is to borrow it from friends and family -- many people prefer to ask their loved ones for a loan rather than a gift. Of course, you must repay borrowed money, and the lender will notice this addition to your debt burden when considering your debt-to-income ratio.

But borrowing from friends and family can be a good idea if:

• You're short for the down payment, but have a relatively high monthly income. If lenders conclude that you have enough income to pay a first mortgage and another loan, they'll typically let you borrow up to half of the down payment. Most lenders will usually require that at least 5% of the purchase price come from your own funds.
• The person lending you money for the down payment will accept no, or very low, payments for several years -- by which time the house will likely have risen in value and you can refinance the mortgage and pay off the down payment loan.

Before arranging for a loan for the down payment, check with your lender or loan broker to be sure that your plan will be approved. Most will require that the loan be pegged at "market" interest for a minimum of five years.

Sharing Equity

One way to enlist the help of family or friends, or even an investor, is to give up a share of the ownership of your house in exchange for a cash contribution. Assuming that this person doesn't actually share your house, however, such arrangements can give rise to conflicts. With one of you viewing the house as a home and the other viewing it as an investment, issues such as the need for remodeling, or the other person's desire to sell the house, may be hard to resolve.

Substituting a Second Mortgage for a Down Payment

A principal function of a down payment is to bridge the gap between what you can borrow and the purchase price of the house. If a lender will lend $350,000 on a $400,000 house, you can make up the balance with a down payment of $50,000. There are other ways as well. One is to get an institutional lender or in rare cases, the seller or a private investor to take a second mortgage for some or all of the $50,000.

In addition to reducing the down payment, a second mortgage may allow you to avoid buying private mortgage insurance (PMI), which most lenders require if your down payment is less than 20%.

The down sides of second mortgages include that:

• Their interest rates are often higher than first mortgage interest rates.
• You must have a relatively high income to afford two mortgage payments.
• A short-term second mortgage with low payments may have a lump sum (balloon payment) at the end. If the house is fairly priced, house prices increase, and interest rates don't go through the roof, you shouldn't have trouble refinancing the first mortgage to pay the balloon payment. But if refinancing proves impossible, you'll need another way to raise the cash (or face foreclosure), unless your second mortgage lets you either gradually increase payments or delay the payment date if you can't refinance when it first comes due.

Using Equity in an Existing House as a Down Payment on a New One

Trading up is an integral part of the American home ownership dream. You buy a starter house, wait for it to go up in value and sell it, and use the profit as most or all of the down payment on a nicer house.

Assuming a rising real estate market, trading up to raise down payment money works better than saving money or making other investments, because purchasing a house is a highly leveraged transaction -- the amount you invest is only a small part of the amount you borrow. In any leveraged transaction, you see big gains not only on your money, but also on money you've borrowed. For example, if you put $20,000 down on a $200,000 house (borrowing $180,000) and the house jumps to $300,000, you've made $100,000 with a $20,000 investment. By contrast, if you deposited the same $20,000 in an unleveraged investment, such as stock or art, and it goes up the same 50%, you'd end up with $30,000.

Next Steps

Once you've scared up some money to use as a down payment, you'll need to qualify for a mortgage.

Buying a House in the Golden State? How to Buy a House in California, by Ralph Warner, Ira Serkes, and George Devine (Nolo), contains practical, up-to-date information about the financial realities, legal rules, and real estate customs of buying a house in California. It covers finding a arranging financing, making an offer, negotiating, and more.