I want to add a zombie dance sequence with one of my quests (UMPA dance + 28 days Zombie). If I pick a song (mp3) and include it with my mod, what is the legality? I can see videos of the songs I would want to use (like http://www.youtube.com/watch?v=FeZftK2kO6U (1962)) on YouTube any time I want.

Is there a difference between a video you can watch and actually letting people download a song used in a mod? I think there are free programs you could use to get the song from YouTube for your own use.

You need to check the permissions associated with the song you want to use and the fair use rights. Generally, the word is that it is illegal.

The song is probably on Youtube illegally in the first place, so don't just assume that because it's on there it's OK. Even if Youtube had permission to host and stream it, depending on the licensing you probably wouldn't. People will probably chime in quoting fair use, of course, but it's best just to say that it's a tricky area for lawyers, let alone the rest of us.

A good rule of thumb is that if it isn't obviously licensed freely, then you need permission to use it: as an example, I have written permission from Chris Hastings to use the avatar I use here, which he drew. Written permission is good, because then you can 'prove' it (though it's not exactly hard to forge an email...).