External drive all the way. 1) cheaper, 2) more reliable.
Get two externals and your system can be even better. Use one for a time machine backup, use the other for your iphotos & itunes libarary and other big files you have. The backup drive should be at least as big as the sum of your internal and data drive.
External 1, 1TB use for data
External 2, 2TB use for backup
Your mac can use FW800 drives. I would however get USB3 drives and plug them into your USB2 ports. They won't be as fast as they can be but if you upgrade your mac in a year or two, you'll be glad you did.
Smaller portable external drives are particularly useful.
Use a permanent External for your Time machine and with the portable(s) you can top up, say once a month and keep them well away from its usual location. This holds benefits if you have power surge problems or a personal need to file long term and maintain security.
Remember, films and albums absorb most memory.
you are going to have to delete, move or archive your data to regain at least 15-20 GBs of empty hard drive space.
Have you emptied your iMac's Trash icon in the Dock?
If you use iPhoto, iPhoto has its own trash that needs to be emptied, also.
If you use Apple Mail app, Apple Mail also has its own trash area that needs to be emptied, too!
Other things you can do to gain space.
Delete any old or no longer needed emails and/or archive older emails you want to save.
Look through your Documents folder and delete any type of old useless type files like "Read Me" type files.
Again, archive or delete any old documents you no longer use or immediately need.
Unistall any third party applications in your applications folder that you no longer use.
If the app has no uninstaller, just drag it to the OS X Trash icon. If the app has an uninstaller app, use this app to completely Unistall the application. Remember to empty OS X trash, again, when you are done deleting apps.
Download an app called OnyX for your version of OS X.
When you install and launch it, let it do its thing initially, then go to the cleaning and maintenance tabs and run all of the processes in the tabs. Let OnyX clean out all web browser cache files, web browser histories, system cache files, delete old error log files.
Typically, iTunes and iPhoto libraries are the biggest users of HD space.
You may have to Purchase an external FireWire or Thunderbolt hard drive to move these files/data off of your internal drive to the external hard drive and deleted off of the internal hard drive.
If you have any other large folders of personal data or projects, these should be moved, also, to the external hard drive and then either archived to disc and/or deleted off your internal hard drive.
Thanks everybody for the advise!
I wasn't aware IPhoto had his own trash folder. Together with the work that OnyX did I got back about 45GB! Most of that gain consisted of IPhoto's trah folder and the removal of old ITunes libraries. These actions give me some time, but the harddrive is still 90% full. I plan to use my current 1TB external drive (Iomega; which I use for Time Machine) to move my photos and movies and add a new 2TB external drive for Time Machine. Is there a good affordable drive you could advise? Thanks again, this was a very helpful reply and welcome to the Apple Support Communities!