This is something their screening probably would have caught, or their system would have a legal procedure to deal with it.

Or paying off my debt, while I provide them with a nice house to live in instead of an apartment. 

Incurring debt before you have sufficient earnings to support that debt.

I don't want to rent it out as it seems like an electrical liability - and I'm not sure if renting it to others would be legally possible seems how we don't own the land.

Depending on your debt to income, you might have to sell or have an executed lease to secure financing to buy the second home.

This may result in late fees and eventual eviction if not cured within the legally provided time. 

I literally laughed through the phone at his suggestion, because I was broke, in debt, and in every way and unqualified borrower, and the lending environment in 2012 was probably stricter than it had been since the invention of the 30yr mortgage.

The 2-3% points in extra cost are worth it if you plan on using as I described above because the use would be for a few  months at most and due to that short term use you can survive a rate adjustment up.But, if you have no plan to payoff the debt like when using for a down payment on a long term hold why pay the extra cost for flexibility and have the additional risk of the adjustable rate with the amortization looming when you can get a fixed rate second mortgage. 

Do not rely on it for legal advice.

Some people only want 10-20% of their outstanding lines/debt balances available while the other 80-90% to be in fixed rate notes.