You have the right idea about installing the boot camp update after Windows 7 is installed. That's the correct way to do it. That part is OK.

Your other problem is that your hard drive is fragmented so that there is not enough contiguous space in order for the Boot Camp assistant to create a partition for the installation of Windows 7. The error message you received is rather confusing and usually leads many folks to the wrong conclusion.

How to solve it:

There are two ways to resolve the error. The first method is to erase the hard drive and reinstall. Prior to erasing, use Time Machine to make a complete backup of the drive. Then during the reinstall of OS X, when asked, use Time Machine to restore. That will clear up the fragmentation.

Second method requires the purchase of disk defragmenting software. I personally use iDefrag but there are several others. Note that defragmenting a large hard drive may take hours and usually will run overnight. It also requires booting into a controlled environment where the defrag software has complete control over your machine.