The only "payment" we're held to is a low interest-only cost, so it also maximizes flexibility, were something to ever go wrong. 

Either way, you can increase your cash-flow up-front by doing a cost segregation study and maximizing your tax benefits.

It really sounds like you are trying to maximize the return on this tenant's occupancy by withholding as much of the tenant's security deposit as you possibly can.Making the statement "I know they are lying" given the utter lack of any sort of evidence except an omission from a home inspector's notes...further evidence this industry might not be the right fit for you.

Or try to maximize the time out as much as possible and refi near the end of the 5 year balloon?

We would then be responsible for paying him for the equity on the property (140 payments of $1k/mo)2) We want to maximize cash flow on the property, and my best guess is rent will be $1700/mo3) The house will likely be used to pull cash out to finance another real estate purchase in the future since we will most likely have between 65-100% equity in the house.

Purchase a duplex in San Diego and live in one unit - PROS: essentially get help paying my mortgage via rental income, proximity to rental property, maximizing FHA loan on a more expensive property (maximizing my down payment in a low interest rt environment) CONS: The market is so unbelievably expensive and rents are not comparatively high enough to really make most moves profitable, high Debt to Income ratio thereby limiting my ability to purchase again2.

That being said, if you owner occupy and use PMI, it is an excellent way to maximize your cash on cash return.

Every dollar also increases our credit line to pull from, maximizing flexibility.

I simply would like to maximize my money/options.  

The Tip for the startup of a Real Estate Career is to maximize your exposure.