Note: What I'm about to describe was NEVER an issue on my 6 yr old laptop but on my 2 yr old desktop, is a pain in my ass!
Basically no matter what I set the recording input level to, when I play my guitar, it records super clipped and distored. During while I am playing, it sounds normal...quiet, clean tone...but during playback it is clipped (the waveform is off the limits) and super distorted....this happens regardless of how high or low I set the recording input slider on the Windows Audio Mixer (I am going through my soundcard)...HELP!!
Sounds like an impedance problem with the sound card or has it ever worked correctly before? It's like running a line in signal into a mic input. Way too hot of a signal no matter what the setting is. You could try getting updated drivers for the sound card but I wouldn't hold my breath. Or you could try an attenuator to reduce the level going in to the input but it could still be just as noisy.
I believe what your hearing that sounds fine is the sound passing through the sound card and to the speakers, not what is being recorded.
Bottom line is...
I would suggest getting a USB or Firewire interface with and ASIO driver for low latency and high quality audio recording. Internal sound cards generally use lower quality hardware with limited inputs. USB interfaces can be found for less the $100.