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Iceland - July 2010?

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My family of 5 (Hubby, 3 kids ages 7,9, and 11 and me) were looking for an adventurous European destination (for a week's visit during July) , and stumbled upon Iceland. It just sounds beautiful, and as a family who loves the outdoors, I think it would suit us perfectly! A few questions for those of you who have been there:

I have found two flats/apartments in central Reykjavik within our budget. Although Reykjavik would have many activities to keep us occupied, it sounds as if there are some beautiful sights outside of the city.

Does anyone have some favorites (Suitable for our kids' ages? We love to hike and stumble upon unique geography.)

I hear rental cars are expensive. Would you advise renting a car, maybe for part of the stay or taking a guided tour or both? If anyone suggests a guided tour, do you have a good tour company? I do love to research areas, and my husband has already driven on the "wrong" side of the road in a few countries, so I would value anyone's opinion on how tough driving is in Iceland.

How's the weather in mid-July? Interestingly enough, today it is warmer in Iceland than it is in Ohio!

I would appreciate any feedback! ~Thanks so much

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