Ran into a hiccup when lender initially told me they would finance 85% of the loan now has changed to 75% but I only took out money from my 401K to satisfy what she initially told me. 

Once the property is stabilized and the seasoning period is satisfied, you should be able to get a conventional loan.  

A more direct, faster, and less costly approach would be to ask the Senior Zoning Inspector if I could obtain a letter that says it could be rebuilt in the over-50% scenario, which would then satisfy lenders- as lenders have already confirmed.  

@Justin Husband By no means exhaustive, just a few thoughts....some pros to selling: -since the property appears to have transferred at death, you may benefit from a stepped up tax basis if you sell (consult tax expert), -strong sellers market now- hard to find good builders now in many places- avoidance of building and renting headaches- some pros to fix and flip:Can be satisfying to see the house turn around, although not worth the headaches for manyMaybe better profit if you do it right and get the profit a flipper might make too Some pros to fix and rent:As previous poster noted, if it cash flows well you have long term cash flow.

I'm just thinking outside of the box...I'm curious to see how Dodd Frankentstein affects these types of investments and the ideas creative investors come up with to satisfy this Act.

I can use FHA owner occupied financing in the background to purchase a similarly cash flowing multifamily every year or so, (just until i've satisfied the live in requirement and save enough money)

It's going to take around 15k to satisfy the debts.Any tips or advice would be greatly appreciated.

Does it mean the seller will not be able to close the escrow if he cannot satisfy all the payoff demand?

Satisfy the above with no leverage and you'll have a property that provides some of the best long term risk adjusted returns. 

Like people said, if you are not satisfied with the number it was given, you could protest by providing information such as COMPS and/or do another appraisal with the cost out of your pocket.