4. Use our $175,000 cash to buy a house in San Diego while we still have 800+ credit scores and walk away from the Tempe condo (not sure if we have recourse loan – do remember the broker made it a “secondary home” loan to get us a competitive rate)

This is correct answer if your loan is non-recourse. Those $40K that you over paid will turn into $100K+ by the time you add the loan interest, taxes and loss in earnings if you had invested that money. Let the bank take the hit. Everybody else is doing. Think of the children, you can send them to college with that money.