Before you can make any decision you need to know what is leaking and what the repairs would cost. 

If the HOA needs to approve the sale, not letting them in may cause problems with your purchase. Also, not letting them in might cause whatever problem there is to get worse and cause it to cost more to repair.

So you are renters and landlord tells you to not let HOA in? This makes no sense. I'd not listen to him. If you are a renter, you'd likely not have to pay. Landlord will have to 

He wants you to buy leaky condo from him? And it's so small that kids don't have a bedroom? No thanks. It's insane 

I find it weird that your DH is ok renting a place that has no room for girls. How is it ok? Old couches? Not good. Even in my most struggling one income single parenthood I always made sure there was a bedroom for my DD. If I had two DDs, there'd be ok there too.

Move out of the condo and rent a bigger place. Get an apartment. Later you can buy a house. If you want condo there are plenty bigger size ones. We own three bedroom condo. Plenty of space.
You can't live with two kids in such conditions. 

don't buy leaky small condos wuth no place for kids 

If you know that you don't want to stay in the condo, I would not buy it. Unless you really do want to buy it as an investment. Otherwise, buying now, then buying in a couple of years is a waste of money (closing costs, inspections, appraisals, etc.) and stressful (trying to buy, and hope you sell at the same time).

If you do want to buy it, please make sure to go through proper channels (contract, lawyer, inspection, etc.). Buying privately, no interest, just pay the rent as mortgage; I have seen that go VERY badly.

When I bought my house (20 years ago), I held out for what I wanted. I didn't want to have to do it all again, a couple of years later. I think it frustrated my real estate agent that I wouldn't just settle for something, but I'm glad I waited for my house.

What does your gut say?

Rent to owns can be tricky. I would have the landlord present a contract and review it with an attorney or have reputable real estate attorney write one for you. 

My concern over buying right now is that the market is crazy high and this bubble will burst. Will that put you in a position to where you can't sell and you don't qualify for the home of your dreams at the 2 yr point because of the condo?

Also, have you tried another lender? My brother was turned down last year by our lender and found another with a better interest rate than we got and was approved without issues! Talk to a highly rated Realtor (Not real estate agent, there is a difference) and find out who they are seeing good results with. (Baby bro had only been with his company for 4 months). 

Don't buy it. It doesn't suit your family and you don't trust the HOA (or your landlord doesn't). The only way it would make sense to buy it is if you want it for rental income in the future, with all the headaches that entails. 
 

My guess is that it's also hard to sell, which is why he's giving you such a good deal. 

I know it's tempting to want to buy "something" because waiting due to your DH's 1099 status is frustrating.  But, in the end, this home doesn't seem to suit the family.  Kids should have rooms..if not of their own.. at least to share.  Sleeping in common areas may be ok for a short term solution.. but shouldn't be long term.

I have purchased many pieces of real estate both from traditional lenders and also with owner financing.. and owner financing can be a decent option if you aren't in a traditional way with your finances.. but it usually will be a bit more costly as far as rate.  Absolutely, either transaction should be legally processed as a sale transaction.. no "private" paperwork that is not filed with the courts.   A lawyer can best advise you how to proceed if you do want to pursue something like that.

I would advise against buying this particular place though.. BUT.. you should consider working with a buyer's agent to help you look for and possibly get connections for financing if owner financing is not possible.

Even in this market.. there will still be some owners that may be willing to sell and finance.. but you may need a higher downpmt.. or expect to pay more interest.. and the home may have issues that make traditional financing difficult for the seller... like may have some work done that wasn't done via a building permit.. or need some major repairs that the seller wants to just sell "as is".  Not all owner financing homes are undesirable.. but they may come with some baggage.. so be aware of that.. just like your current home... he may be seeing this as an easy way to avoid the cost of sales commission.. or to get out of having to do repairs/renovations that would be needed to get market value.

I would also see if there are other options for financing that may not require that 2 year wait.  You went through the process with one lender.. but that may not be the same requirement for ALL lenders.. there are many loan products and depending may have different requirements.  But, again.. there could be some additional cost/rate to get around that 2 years.. you would just have to look at the full balance of pro's and cons.

It seems like the real Pro here is buying right now.. but the con is that you don't really want what you are buying  because it won't suit you..