He will apply for a new passport when his old one expires. He doesn't need to go back to the US to apply -- he can send the application to the US embassy in London.
The passport's expiration doesn't mean his spousal visa will expire. He'll just need to carry the old and new passports together when entering the UK and he'll need to produce both when he applies for his ILR so they'll be able to see his FLR in his old passport and can put his ILR in the new passport. He can apply for ILR up to four weeks before the FLR expires, so he could theoretically apply in person in Feb 2008, which would put his FLR and ILR in the old passport. He'd then apply for the new passport and would need to carry both (or pay an additional fee to have the ILR transferred to the new passport).
If you'll be living with your parents, they'll need to send a copy of their lease/mortgage and a letter saying that you'll be living with them when you apply for your fiance's FLR. They'll want to see your bank statements and a letter from your employer as well.
