About 5 years ago I got new windows! Yeah!
Apparently the bathroom(shower) window has been leaking since then (BOOOO!) I figured this out when the tile of the windowsill started popping loose. I decided to replace the window sill to prevent moisture getting into the wall, but apparently I'm WAY too late... The supporting wood under the tiles is completely rotten, wet and spongy. What I can see of the vertical boards up the sides of the window are also damp but not as far gone rot-wise. The exterior of the house is brick, so I can't really get rid of the window but I'd rather not cover it up either. I'd like to replace the tile in the tub with a tub surround and have it meet up with the tile in the rest of the bathrooom right at the edge of the tub. The window poses a problem though unless I can find a surround with a window or one that I can cut a window opening in and put some kind of custom edging around the window opening to finish it off and seal it... HELP!

I've started removing the old tile, but am beginning to wonder just how far it will go with the water damage... I really can't afford to hire a contractor so am determined to do this myself. ANY advice would be very appreciated...

There are several options.
You can use a solid surface material such as Corian or Formica Solid surface. Many nice colors to choose from. It can be cut and shaped real easy. Cost however does come into play. the nicer colors are fairly expensive.
Many tub surround kits can be cut for openings as well, they just do not look as good because most cutting does not provide a finished edge trim.
The tile removal process along with the decay will be what it is. The water damage will only get worse as you move down the wall below the window.
If you have not removed the tile on the side walls and have not got to far removing the window wall tiles. Once you get to the end of the rot, you could always reframe the damaged area and use a tile that will accent the older tiles so you do not have to remove all of them.
But if you decide to go the whole route of removal. Be sure to upgrade the faucet, shower head and plumbing behind the wall. As it will surly leak once your get your new walls up and done. I think its called Murphys law.

You're right about Murphy! Thanks for the assistance!