1) what is the best way to backup and copy files over? From my udnerstanding you have to wipe the drive.
2) What is the costs and does any windows 7 work or do I want an upgrade key?
I would suggest Files and Settings Transfer Wizard (FAST for short). An external drive is handy for this
FAST doesn't move installed applications butdoes copy folders, address books, e-mail accounts and messages, Internet Explorer favorites, Outlook data, and most other crucial files and settings. It's easy to use and comes installedwith Windows XP.
Click Start > All Programs > Accessories > System Tools. The utility can copy all your stuff via a network, a direct cable connection between the two PCs, or removable media (like a portable hard drive). It works very well.
However, if you have files in non-standard locations, you will need to manually copy those files
There is alos the USer State Migration Tool (USMT) fully detailed at this Technet site Similar to FAST but designed for IT staff.
I would recommend you purchase an external USB drive and copy any files you would like to save over to that drive. Here is an example of an external drive: http://amzn.com/B00834SJS0
If you already own a copy of Windows XP - You can purchase Windows 7 Upgrade and save some cash. Depending on what you want to do there are several versions of Windows 7 available. Here is a list of all the differences.