Delete the MacBackedUP you created. It sounds like you don't have enough space on the harddrive to complete the backup.
The thumbdrive you pointed to will not be big enough. You will need a firewire drive (or something similar) like this:
http://store.apple.com/us/product/TN975LL/A?fnode=home/shop_mac/mac_accessories/storage&mco=Njg3NTAy
VirtualBox is just like VMWare or Parallels in regards to a virtual computer running inside OSX. Windows XP will run slower this way. I haven't messed with VirtualBox for OSX but have for Linux and it seems to run fine. I would recommend to give it a try since it's free.
Hope that helps!