It is very possible that knownhost has blocked hotmail email addresses due to an inordinate amount of fraud stemming from such free e-mail services.
You can still use the same paypal account - when you get up to that stage of the order you would just login with your hotmail account to paypal but you can still give knownhost a different(non-hotmail) e-mail address to contact you with.
Hotmail and MSN we don't allow when ordering. This came about from the mysterious dropping of emails from hotmail. It most cases everyone gets emails there but there seems to always be some who don't so we eliminated it all together.