3 rentals and looking to expand

[Clinton Keith Cunningham]

I have two single family homes with CF combined $600 a month. Debt payoff on home # 1 is 28k with low fixed rate debt. It rents for $850. I am needing to refinance home #2 from an ARM loan to a fixed rate. I have two scenarios I am considering. I do want to grow my real estate portfolio. I wanted feedback from the great people at Bigger Pockets.

1) Refinance and pull 20k out of home #2 to pay off home #1. My thought process would be I would increase cash flow. It has a long term tenant in the property. IF and when the tenant leaves I could turn it into a short term rental. It is near a hospital so I was considering marketing to travelers. With it paid off I would feel more comfortable jumping into the short term rental game. 

2) Refinance and pull 20k out of home #2 to use as a DP for a new investment property. 

3) My w2 income has increased and I could it to save for a 20% DP for a new property without doing a cash out refinance on home #2. This would keep CF at home #2 the same or may increase after the refinance.