Well, for sure you won't be able to operate your laptop without an internal drive. If you read the Step-by-step guide here, you'd see how replacing the Internal Hard Drive is a fairly simple operation. So simple that, when your laptop was still in warranty, doing that wouldn't have voided the warranty agreement.
The decision between an internal replacement or an external isn't something anyone else can do but you, but I could give you some checklist to go through to help in your choice.
1. Do you need the extra space always with you? I mean, do you use your computer at home, as some kind of "desktop replacement", occasionally bringing it around, or always around? In the first case, you could keep an external disk on the desk and you won't feel the difference, in the latter, you'd start to regret having one USB always occupied (you sure can't use an USB hub on the train, and a powered USB one in the library).
2. Do you need the extra space only for music and videos? And how often do you plan to listen to them? If you can do without for long periods, an external drive is kind of a big pendrive: when you feel to dance, snap it on and play. If you can't live without iTunes, and your Hard Drive is filled to the brim, an internal drive is good
3. Are you on a Budget? If that's so, sometimes sellers may offer deals on the external units, lessening the gap between the price of a drive and the couple drive plus enclosure (that, basically, is an external drive)
Add to this checklist the fact that, if you choose to get through the replacement route, you may want to copy the contents from your old disk to the new one. So you may have to download some software (Carbon Copy Cloner is free, AFAIK) and get someone to lend you a third drive, or an enclosure to temporarly lodge your new one. However, since drive enclosures are fairly cheap (from $ 10,00 to $ 30,00), you could get a cheap one, and keep using your old drive as an external spare.
If you choose to get an external one, at the current technology level every unit coming from a good brand is exactly as good as the others. I had a good experience with Western Digital, as when my unit died on me at a week before the warranty expiring they changed it unflinchingly, with no cost attached, with a unit of the same line and design in almost no time.
As for the limit: well, the price is the limit. The more you're willing to shell out, the more you can get a SATA drive. On my Macbook, I must tell you, I've got a 320Gb and I always keep it half vacant. But guess it depends from your use.
So, to summarize up, if you're willing to go through the hassle of moving data from an hard drive to the other, and you find a better deal on an internal drive, go for it. Remember to ask your Apple Genius if the model you're buying is 9,5mm thick or less, since otherwise it won't fit or bulge, and read throughly this guide ( MacBook Core 2 Duo Hard Drive Replacement ).
Is something you can do by yourself or with a friend? If yes, and if you can deal with getting an external enclosure or reload every scrap of data you've got from backup, go for an internal drive.
Otherwise, get an external, of a good brand quality.
As a side note, I must forewarn you that technically this place isn't staffed by the iFixit support staff, but by a community of iFixit enthusiasts, as you are.
However, iFixit sometimes has some sweet deals on hard drives and similar stuff, and you may give a good look.