I lived in Spain for about ten years.
Castilian Spanish, aka castellano, *is* the Spanish spoken in Spain. Spaniards use it to distinguish it from e.g. Catalan, Gallego, Valenciano - the languages (and in some cases dialects) of what we call "Spanish."
http://en.wikipedia.org/wiki/Castilian_Spanish
I think Spain is a great choice for your kids. If I were going for the language exposure/practice, I would avoid Barcelona/Catalonia because Catalan is spoken there and some in that area are even hostile to the Spanish language. I would instead likely fly into Madrid, spend a few days there, and then travel to Castilla/Leon areas, e.g. Burgos, Leon, Zamora, where people are less likely to speak English, and less hurried/more interested in engaging with your kids. As a culture, Spaniards love children and treat them very very well. Virtually nothing (especially in smaller cities/towns) is viewed as adults-only and it is commonplace to see kids out with their families at midnight and beyond, playing while their parents enjoy a drink.
The whole Castilla/Leon area is dotted with castles, forts, and cathedrals which I am sure your kids will find interesting. You can stay in a parador or two which they will LOVE:
http://www.paradores-spain.com/
Depending on how much time you have, you could go north to Galicia/Asturias/Cantabria, which are gorgeous and interesting regions. There are some lovely little medieval towns (Comillas, Santillana del Mar) which your kids would thoroughly enjoy and which, again, would be unlikely to be populated by people eager to speak English.
Have a wonderful time!