Hello,

I just got off newbie island and tried to clear the castle. It was understandably more difficult now that I don't have healing wells, pedestals of haste and +50 to all stats for the entire party...

I died.

Then when I tried to rest, goblins attacked, and my archers machine-gunned (what it feels like with 4 bows) a guard by accident.

I died again.

Both times I pop back up with 1hp on all my characters. Is there a death penalty that I should be afraid of? Do I lose XP or gold? The game says I cheat death, but I have a feeling my 9 lives are going to run out.

I guess you mean MM7 ;-)
You just loose all the gold you're carrying, but not the one stored at the bank.

1) You lose money on hand
2) Time passes, in case you care about that. (Theoretically, your characters age, too. Although the effects are minimal if there are any - as far as I could tell only unnatural aging affected them)

In any case, neither is significant

Time spent is quite significant if you want to complete the game with as high a score as possible.

and any NPC you may have hired (at least in VI.)