Our two week trip itinerary in Sept:
Arrive in Madrid and take a bus to Toledo.
Toledo - 2 nights at Hotel Santa Isabel
Catch a plane to:
Barcelona- 2 nights or 3 nights at either Montecarlo (great reviews on Tripadvisor) or Banys Oriental. While the Montecarlo is pricier, it appears to be a closer walk from Placa Catalunya where the bus will drop us off.
Originally, we were going to take a loop from Madrid to Toledo, to Sevilla, Granada and up the coast to Barcelona. But we found out that the Festival de la Merce would be in full swing. We weren't crazy about being there during the madness since this is our first trip to Spain.We'll rent a car and drive for the remainder of the trip.
Santa Pola and local area - 2 nights. Fewer nights in this vicinity is not possible because my husband wants to visit with a dear friend. Any suggestions on what/where to visit while we are stationed there, such as Alicante or Valencia?
Granada-2 nights - hotel recommendations that won't bust our wallets?
Sevilla-2 nights - hotel recommendations?
Madrid-1 night, possibly staying at the HH Campomanes.
It appears to be a bit of a whirlwind, though we are accustomed to and enjoy road trips in the U.S. We would also like to see as much as possible so that when we return, we will know what areas we want to spend more time in.
Should we shave a day off from Barcelona and take time to visit the white villages in Andalucia? We both speak fluent spanish, as we were born in Cuba. And we're extremely excited about visiting our grandparents' homeland (Barcelona and Granada).
We appreciate any and ALL recommendations/comments on our itinerary as we want to make this trip memorable! How about restaurants? We have a fairly decent idea on things to do/see.

Is there any way you could change your itinerary to arrive in Barcelona? There is an airline named Vueling which operates from that city that could get you to southern Spain. I am not sure which cities it services but their website should help you. You could then visit Granada which is a family priority for you and then go on to Seville. from Seville you can train to Madrid for the final portion of your trip. Toledo is an easy side trip from there but I do not think it necessary to spend two days there. On a first trip to Spain there is so much to see. . If you prefer to drive there are even more options.
I am not sure about the festival de la Merced. However, I think it that the loop you mention which included a drive from Granada to Barcelona would be rather a lot of driving.

Thanks for the information. We'll be arriving in Madrid early Sunday morning and thought we would take it easy on our first day. Since Toledo is not far from Madrid (we didn't want to stay in the city), we decided we would hop on a bus to Toledo, since we had read/heard great things about it AND the fact that it was close and doable. That way, we could spend Monday touring the city and leave early Tuesday to catch a morning flight (already booked on Iberia $18.00pp or euros - I can't remember- plus fees) to Barcelona. So, we're stuck leaving to Barcelona on the third morning after arriving in Madrid. If there are other suggestions for spending that time in the general area, we are game!
We will spend two or three nights in Barcelona. At departure, we'll rent a car (prices for one week are running about 180 euros-Avis & Hertz.
Santa Pola appears to be about midway between Barcelona and Granada, so that portion of the trip shouldn't be too bad since we will spend two nights there (I'm trying to convince my husband that one night is plenty, but I'm not sure it's going to work). Maybe we can stop in Valencia for a lunch of paella before arriving in Santa Pola.
I think one of our delemmas is whether to spend two nights or three nights in Barcelona so that we can spend a day elsewhere - suggestions?
As for your suggestion on the train from Sevilla to Madrid - I'm going to check right now to see if we can drop the car off in Sevilla-for less driving.
We read a great review on Fodor's about the Alhambra Parador and are considering splurging on this.

Looks like you will be in Toledo right after arrival in Madrid. Just make sure you see El Greco's masterpiece, The Burial of the Count of Orgaz.
Two or three nights is NOT too much time for Barcelona. I am not sure of Santa Pola's location but from what you say it cannot be too far from Valencia. Tarragona might make a nice stop en route.
The Parador in Granada is arguably the most popular in Spain and hard to reserve. You might be lucky to get a room in September but don't count on it. You might want to try the Hotel Guadalupe. After that I am not sure how much time you will have. You may be able to take in either Cordoba or Ronda before heading to Seville and the return to Madrid. Once you get the timeframe for your itinerary worked out we can make more sensible suggestions.

There is a 'fast train' service now from Madrid Atocha station to Toledo. Takes 30 minutes ! The connection between Seville and Madrid is good and the train is excellent if you opt for the AVE it's very smooth. About 2 1/2 hours. www.renfe.es
I just stayed in an IBIS hotel at Seville and Jerez. IBIS is a French chain of modern functional hotels and average cost of bedroom was 52 Euros. they are easy to find and have good parking and are usually situated away from the city centre so maybe ideal if you are driving and don't want to get lost! At Seville, the IBIS is on the road leading out to the airport and Cordoba. I caught a bus from the hotel into Seville for one euro. Frequent buses.
But frankly, there are hundreds of hotel bedrooms in Granada and Seville - spoilt for choice !