You're running Office 2007? That has better handwriting support than the previous versions. It sounds to me like you definitely need to remove Office and reinstall.

The way it works for me is I launch Word and then in the language bar I click the handwriting input and select Write Anywhere. With that selected I can then write directly inside Word and it converts as I go. Note that the cursor does not change unfortunately so you'll be writing with the I Beam cursor, but you'll see how it works. That is all there is to it. I actually prefer using it on XP in Office than in Vista because Vista insists on "helping" you by forcing you to use the Tablet PC Input Panel which is a bit more clunky than just writing inside Word, however Vista's translation algorithms are better.