In a way I'd rather KOTOR III be on the same engine, if no other reason than to give the entire series a "Trilogy" feel to it. If I and II are on the current engine, then III is made on a vastly near (and improved) engine, the three games might not seem like they're part of the same series.
As far as the Source engine goes, I'm not sure it works well with a cRPG. The technical issues with Vampire: the Masquerade Bloodlines has been plentiful and this is even seen on high end machines, not just machines that barely meet the minimum reqs. Unless it was just Troika who did a piss poor job, I'm not a big fan of the Source engine in terms of its use as a RPG engine.