What should I look for in a used PS3? How important is a bigger HD? What does the HD space get used for? Just saves?

Most games prompt you to install them to the hard disk, which reduces load times.  If you don't want to sit through the sometimes lengthy installations more often than you have to, get one with a bigger HD so you can leave all of your games installed/patched.

there are also downloadable PS1 games on PSN.

Backwards compatibility might be something.

I'm unlikely to have more than 5 games in rotation at any one time, and I will NOT be hooked up to PSN because I don't have DSL or Cable internet right now. Based on this would a 40 gig be enough? Thanks guys.

40 would be fine then, i've had mine a while and havent maxxed it out yet. the cool side is, if you DO max it out, the bulk of laptop drives will work in its place. i think you can put up to a 250 in it.