If you find a home in the Midwest that is cheap enough for you to save 20% for a down payment instead of 3.5% you could get a conventional loan and not have to wait. 

Having a couple of credit cards, student loans, car payments, home loans, etc. and paying them ON TIME every month will increase your credit score. 2.

I'd take whatever money they are willing to give you (accepting partial payments in ME is fine) and then hand them a 30 day notice.

The loan won't be amortized over 6 month, it'll probably be something like 20-30 yr interest only balloon payment at 6 month. 400k @ 12% over 12 mo is like 36k mo400k at 20 yrs, something like 4,400 interest only and then balloon of 400k due at end of that 6 mo.

Get financials of tenant and payment history to make a decision.

I have money saved up that I was intending to put towards a down payment...that I'm now sitting on.

Bought it for $179k owe $171k and it appraised 3 weeks ago for $193,500, but if we add a closet to make a 4th bedroom the REA said it could have potential to sell just above $200k.Should I take the equity and pay down debt and keep the house and save the extra money after paying down some debt until I have enough for a down payment for an investment property?

Anthony's advise is good but also you can also negotiate the Realtors commission or payment.  

In the last few months she became late, but always caught up with rent, in June she missed a payment completely and the check she wrote for the balance  of May bounced.

Our first goal is to develop enough passive income to replace our own mortgage payments and then see where this takes us from there.