Joined: Jan 2009
Posts: 44,340
Likes: 6,640
From: New York, NY, and High Falls, NY, USA
Bikes: 1962 Rudge Sports, 1971 Raleigh Super Course, 1971 Raleigh Pro Track, 1974 Raleigh International, 1975 Viscount Fixie, 1982 McLean, 1996 Lemond (Ti), 2002 Burley Zydeco tandem
Right, as a resale, it's very damaged. As a rider, it's barely damaged at all. I think the greatest risk to the bike, not you, is to the paint, so yeah, sand off the buckled paint so you can watch the rust. [MENTION=63590]jyl[/MENTION] makes an excellent and interesting point about risk.
As others said, steel frames fail slowly. It will feel noodly before it fails. It won't just collapse suddenly. And I predict this frame won't fail at all, as long as you watch the rust. Even then, I can't remember ever seeing a frame fail from rust, though I know it does happen sometimes.