Raising the money to cover a down payment and closing costs can be a major challenge for potential homebuyers. In fact, four out of five Americans regard it as the number one obstacle to buying a house, according to a recent survey by the National Association of Realtors.

That same survey also says that three-quarters of Americans also think that right now is an excellent time to buy a house, given sharp declines in prices and near-record low interest rates. So what can you do if you want to take advantage of those conditions but don't have the funds to cover the up-front costs?

The traditional and straightforward answer is to reduce your spending, increase savings and perhaps find new sources of revenue, like a second job. But while that's always sound advice, it can take two or three years to save the necessary funds, and who knows what housing prices, let along interest rates, will do between now and then?

Fortunately, there are ways to put together a down payment fairly quickly that are within reach of many, if not most, potential borrowers. Particularly if you have decent credit (700 and above), your goal of home ownership may be more attainable than you think, even in the current tight credit market.

First-time homebuyer tax credit.

The first option is the first-time homebuyer tax credit. This is a federal tax credit that allows up to an $8,000 tax credit for first-time homebuyers who purchase a home by Dec. 1, 2009. The plan was recently modified to allow purchasers to use the credit immediately toward a down payment, rather than waiting until next year to claim the credit on their tax return.

Even better, there are movements afoot in Congress to boost the credit to $15,000 and make it available to all purchasers. Even now, "first-time homebuyer" is defined as someone who hasn't owned a home for three years. Either way, the credit provides a way to get a substantial chunk of your down payment right now, although most lenders will also want you to put up some "cash money" of your own.

Home buyer assistance programs

Many states and local governments have home purchaser assistance programs that help people come up with the funds for down payments and closing costs, sometimes as grants or loans that may not have to be repaid if certain terms are met. Although these typically have income and purchase price limits, you don't have to be "poor" to qualify - it's not uncommon for these programs to allow families of four with incomes of $60,000-$100,000, depending on the area, and for home prices as high as $250,000-$780,000, again, depending on the market.

The State of New York Mortgage Agency has a program that provides closing cost and down payment assistance of up to 3 percent of the mortgage amount, in a loan that requires no monthly payments and can be forgiven after 10 years. The Michigan State Housing Development Authority offers a Down Payment Assistance Program for low- and moderate-income home buyers that provides up to $7,500 in a zero-interest loan with no monthly payments, due only when the property is sold, refinanced or when the mortgage is paid off. Other states have similar programs, although purchasers may still be required to put up some of their own money, often at least one percent of the purchase price.

Links to various down payment assistance programs in each state are provided on the Department of Housing and Urban Development web site at http://portal.hud.gov/hudportal/HUD?src=/buying/localbuying

Borrow from a life insurance policy

If you have a "permanent," instead of "term" life insurance policy, you can borrow against it to help come up with a down payment and closing costs. You don't even have to pay it back, although if you don't, it will be taken out of the amount eventually paid to your beneficiaries, so that's worth keeping in mind.

Borrow from a retirement account

If you have an IRA, the IRS will let you tap up to $10,000 of it to use as a down payment if you're a first-time homebuyer (defined as owning a home within the past two years). If your spouse has an IRA as well, you can double that to $20,000. The penalty for early withdrawal is waived in these cases, although you'll still owe taxes on the amount withdrawn unless it's from a Roth IRA you've had at least five years.

You can also tap a 401k, though that is far trickier. If you flat-out withdraw the money, you'll end up paying a penalty unless you're at least 59 ½ years old. You can borrow against your 401k, but you need to pay it back in, with interest, to avoid a penalty, although you're basically paying the interest to yourself. Even so, the repayments will increase your monthly expenses on top of the mortgage itself, so you need to carefully plan your expenses here before proceeding.

In any event, before tapping any retirement funds, be sure to take into account the fact the effect the withdrawal and loss of compounded earnings will have on your eventual retirement nest egg. You may find you're better off to keep renting for a few years and let that money continue to grow.

Sell stuff

Ever notice how much money you can spend on a bunch of little items before you realize it? The reverse can happen when you get rid of it. Holding a yard sale or putting things on Ebay can unclutter your current residence and raise more cash than you might think - at least, another piece of the down payment puzzle.

A gift or loan from family members

Some young adults don't like to ask their parents for money. But parents and other family members are often willing, even happy, to assist the next generation in establishing themselves, particularly when it comes to something like home ownership. It may be a personal loan, a commercial loan backed by assets held by the relative or a gift of part of the estate the relative intended to eventually leave you anyway. It doesn't have to be the full amount; if you're able to come up with the rest through other means, your family member may be willing to help close the gap.

Get an FHA or VA mortgage

One last option is to minimize the down payment required by getting an FHA or VA loan. Although the ongoing costs may be higher due to the fees they charge, you can get an FHA mortgage for only 3.5 percent down and qualifying veterans who finance through the VA are just about the only ones who can still get a zero percent down mortgage. Because after all, minimizing the amount of cash you need is one of the best ways of being able to cover your closing and down payment costs.

Published on July 13, 2009