You're somewhat limited with your budget there.
You got two choices, for £250 you can either:
Upgrade Motherboard/CPU/Memory
With something like
This
Or upgrade the graphics card
With something like
This
Those choices aren't written in stone, I just picked something to suit your budget.
Best bet would be buy both and with the little that's left over from the £500 budget also get a 500Gb hard disk.
I have used Aria as a supplier purely as an example, not recommending them, although imo they're quite good.
Hard to say which of the two main items would benefit gaming the most, I'd gamble on it being the graphics card but I could be wrong.
£500.00 will struggle to buy a complete gaming machine, best to upgrade and use the bits and pieces you already have,
And welcome to the forum
PS: Win 7 most deffo worth it. Will cost between £75 and £90 OEM for Home Premium.