I have stayed at Paradise Pier, and I have stayed off site. We stayed at PP when my yougest was just 3, and then also when he was 5. This time he is 6.5 and we are staying at Howard Johnson. It is absolutely more "magical" for a first trip to stay on site. Personally, I would skip Universal with that age kids unless it is an absolute must do for you and your husband. Some souvenirs are a must, but a lot of them you can get at the outlet mall down the street for much less. By the way our favorite souvenir turned out to be a $7.00 soft back book that we basically wore out from looking at after our first trip. (I later bought several copies at a local warehouse sale and used them in my scrapbook).
Benefits to PP: Quick in and out at GC entrance. We spent a lot of time in Bugsland with my little one. Also, we did not do Fantasyland rides because he was scared of them, but he loved toontown and Gadget Go coaster. Also Mark Twain and Pirates Lair. Basically anyplace he could run around and explore. At age 5, he had expanded to enjoying the bigger rides and we did get to enjoy Splash, Big Thunder Mountain, Space Mountain, etc. Still did not want to go on the Matterhorn again (because of Yetti), didn't want to do Haunted Mansion (but I made him

), Pirates (He hid his face) and still wouldn't do fantasyland.
So, where was I ...we love the WhiteWater Snacks in GC, and ate there at least once per day. It was always quiet and the staff friendly and easy to manage kids in.
If you are doing Character meals (and you should), it was really nice to be in such close proximity to all of them.
PP has a great room service breakfast (great american?) which we ordered everyday, and it fed the entire family, provided coffee for us, cocoa for the kids and in general got us off to a great start.
The pool is great for kids with the little slide, the toddler pool and also the bigger pool. I like that they have life jackets on site for your use, so you can relax a little bit more.
Also, my kids go to bed early, especially after a long day at the parks, even if we have napped. So I loved that PP has the music piped into the pool area to view the fireworks.
Well, regardless of what you decide, you will have a wonderful time I am sure. Be sure to write a trip report when you get back!