I have an old 401k from a previous employer. I am no longer contributing it and it's basically just sitting there. Can I withdraw part of it to use as a downpayment for a first home? I have heard that you can do that and also avoid the penalty (10%) as long as you are using it toward a first home. I only want to use part of it for this purchase, and roll over the rest to my current employer's 401k program. Please advise.

You will of course have to always pay the actual income tax ( state and federal) on the money. There are things you will have to prove to not have to pay the 10 percent

How To Purchase a Home Using a 401k | eHow.com

I think that if you withdraw from 401K for purchase of first home, you will still pay 10% early withdrawal penalty.
You may borrow money from 401K.
Another option is to roll the down payment into a rollover IRA, then make the withdrawal from the IRA. You can withdraw funds (up to $10,000) from a traditional/rollover IRA for a home purchase if you qualify as a first-time home buyer and thus avoid the 10% Early withdrawal Penalty.