If the bearing gets cocked even slightly it will dig into the housing. Sometimes its best to hammer it back in and see if there is a ridge
I know this would be older transom then 1980, but does yours have a snap ring holding the bearing in?
Most boats come with the 1.5 unless their real heavy. Props would be in the 19 and 21 pitch. The 302 not being a power house and a 25foot boat, I would go with the 19
You didn't mention which drive but I'll guess it's a R or MR but motor needs to come out, and while your at it check the transom
https://www.mercruiserparts.com/bam/subassembly/30872/2203/40
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The motors need to be scanned. With slow mode (guardian) and the alarm there will be a code.
Mentioned going from a 5.0 to 5.7 GXI, is the 5.7 using the 5.0 ECM?