The advise below covers much of what you've asked.
I understand your reluctance to default, damage your credit score, etc.
Rent-to-own may not be a bad solution at all. (I'm a big advocate of lease-options in the right situation.)
The first question, though, is: Is the monthly lease amount equal to or greater than what you could receive just by renting? Someone purchasing on a lease-option should pay at least the going rate, and ideally somewhat more.
If the offer is below the going rental rate, you'd be better off with a straight rental.
However, let's assume the lease amount is equal to or above the fair market rent. The next question is: Can you live with a $400 a month negative cash flow? If yes, keep reading. If not, then the offer won't work for you. You'd need to make sure that you can handle whatever negative cash flow you'd encounter.
OK. So let's assume you can (with some pain) handle a $400 a month negative cash flow. And check with your accountant, but you should be able to deduct your rental losses on your income tax, thus reducing somewhat the after-tax consequences of the loss.
The 4% down is nice. That's a good, solid amount for a lease-option. You can try asking for more, but 4% isn't bad. And your lease-option should be structured so that the 4% is non-refundable. And again, check with your accountant, but that 4% isn't taxable until either the option expires or is exercised.
The 3-year period is OK. In fact, it probably suggests that the tenant-buyer is serious about buying. I don't like short (6 month or 1 year) lease-options. In those cases, the tenant-buyer might as well buy. And it's a lot of hassle for the seller, especially if the tenant-buyer doesn't exercise the option.
Next consideration: Can you narrow that $400 negative cash flow? (Assuming the lease amount offered is fair, to begin with.) Here's one strategy: Do a land trust with the property. You'd become the settlor, and your tenant-buyer (under the lease-option scenario) would become the resident beneficiary. There's a big advantage for the resident beneficiary: Beneficiaries of a land trust can deduct taxes and interest from their income taxes. Check with an accountant who understands land trusts. But now you could increase the monthly payment by the resident-beneficiary, but that increase would be more than offset by the tax benefits. For more information, see http://www.landtrust.net
That's the first thing I'd look at to narrow the negative cash flow. But if you decide, for whatever reason, to continue with a lease-option rather than a land trust, you may be able to bump the rent up in return for a higher rent credit. For example (just making these numbers up), let's say your home would rent for $1,000. But with a lease option you'd be charging $1,200, with $300 credited toward the purchase price. Instead, charge $1,300 a month rent with $400 credited toward the purchase price. That becomes even more attractive for the tenant-buyer.
Finally, I congratulate you for looking for alternatives to a short sale.
Hope that helps.