Yes, you can just delete the nandroid folder entirely if you need the space in the future, it won't break anything.
I don't know about updating, but I guess it's worth a shot. What version are you on right now? Also, which type of ext partition are you using, ext2, 3 or 4?
When I've seen that error before, it's either been caused by lack of space, a bad ROM install or when I tried to use Ext4.