So about this pit spell. 2x2 area pit monsters fall in and die on a 1 or 2. Now as far as I know there are no rules to define what should happen if there is no space for the monsters to evade the space (blocked by walls and/or other monsters/warriors).
My group has been playing it that if they can't physically find space they are dropped into the pit and die however we have been limiting it to 1 pit per board section.
I here quote from the Pit of Despair's description in the RolePlay Book:
On a score of 3, 4, 5 or 6 it scrambles out of the way - place it in any empty square on this or any adjacent board section. If there are no empty squares available the model falls into the pit anyway.
In regards to the other concerns (balance issues), I have mostly played with this spell at higher levels in my solo games. I just never have used it much, but yes, I sometimes use it for tactical advantage -- limiting the monsters' access to my Warriors. There are so many things the monsters can do to kill the Warriors even without being able to attack them in hand-to-hand combat. Also, remember some of the higher level monsters with their dispel magic ability will often be able to prevent it.
(edit -- added this paragraph) If my Wizard does not begin with Pit of Despair, I usually find other spells much more interesting when gaining new spells. I sometimes only select Pit of Despair, if that is one of the very few options left for the particular dice I rolled for my new spells.
Often it seems a combat's outcome or difficulty is greatly determined by who gets to 'shoot first' -- whether by literal shooting, or by powerful spell casting. So, again, at higher levels, the monsters who show up which can ambush (especially with Ambush Magic) can really turn the tide of combat in favor of the monsters.
Note: In my games (house rule), I do not allow the Wizard to cast Attack spells at any time. He can only cast offensive magic during his turn within the Warriors' Phase.