For safety's sake, and as I have not used the "Install alongside" option for several years, I suggest you stop the installation, and go back to the desktop of the live CD. Using that, check what the files are in the 3.2GB of files on sdb1, (at least I think it is sdb1, as there is a difference in what the installer says and what fdisk says). However, check any files that show in both partitions currently on sdb and backup any important files, if you recognise them to a usb flash drive.
Having done that, open gparted from the System->Administration menu, and delete both partitions on sdb. Make sure you get sdb from the drop down menu top right and do not delete any on sda, or your windows may be gone.
Now go back to the installation, and when you get to the disk preparation (partitioning) stage, choose "Something Else", ie manual partitioning, usually the third option, I think.
Now sdb will show as 500GB unallocated. Using all that space make an extended partition of the full 500GB, as Linux is quite happy to have the OS in a logical partition, unlike windows. That will show as sdb1. Now within that partition you need to make a new logical ext4 partition of about 10 -15GB with mountpoint /, (root), a swap partition of 2 -4GB with no mountpoint, and a separate partition of perhaps another 10GB ext4, with mountpoint /home. All the remaining space can be made into a new logical partition for data, formatted as ntfs, which can be shared between ubuntu and windows. At this stage do not give it a mountpoint; we can deal with that later after installation. You should now have potentially the following partitions ready to be made:-
sdb1 extended 500GB.
sdb5 logical ext4 10-15GB mountpoint /.
sdb6 logical swap 2-4GB.
sdb7 logical ext4 10GB mountpoint /home.
sdb8 logical ntfs all remaining space about 470GB for data, no mountpoint.
If all is well go ahead and install. Along the way you will be asked for username and password, your timezone etc etc which should all be very obvious to answer, and at the end you will be asked to reboot. Do so!
That should be it apart from the large shared ntfs partition, but let's get this bit done first and then later you can come back and we'll sort out mounting the ntfs partition at boot time, though if you want to have a stab at getting it going, just install the package ntfs-config after installation, and it should be very easy to run that and set up everything.
Good luck. It may all sound very difficult and intimidating but once you have done it the first time, it is very easy to do again when needed.
I've just noticed that you say you can not boot into Win7 even in safe mode. Is this after trying to shrink your windows partitions with gparted, or was this the case even before this ubuntu saga began? If you have a Win7 install DVD disk it may be worth trying to get windows running properly first.
I'm afraid that not having windows in the house, I can't really help on that.