I'm not sure you overreacted at all. It may be that there was little point in arguing with someone who was drunk, but that's not the same as overreacting. Does that make any sense?
Look, lots of alcoholics and alcohol abusers are in my family. I don't condemn them but I don't feel I hold all the blame for getting into an unwinnable argument with one of them! You had every right to draw the line at excessive drinking and the threat of grandparents' rights! It's very hard to stay calm and just have the presence of mind to say, "By all means, spend money on that, and I'll be happy to tell the judge about your illness and compromised state."
So my advice is to not engage her, and not engage your father-in-law. He's in denial, or he sees the problem but is not yet able to confront her because the problem just seems so huge. If he doesn't have to leave her at home, he doesn't have to admit the problem is so big, and he doesn't need to draw a line in the sand. Maybe he thinks he can ride herd on her, I don't know. But he has the same non-confrontational style as your husband.
You may not be able to do anything about either of them, although it does sound as if your husband is on board with Stepmom not being around the kids. Maybe you stop short of "you're never going to see them again" but
So I would encourage your husband to see his dad as much as he would like, with or without Stepmom, but not in your house. I would encourage the kids to make drawings or little crafts now and then to send to the grandparents. I would send photos now and then, such as for Christmas or Grandpa's birthday. That leaves you ignoring Grandma's birthday but you could send her a photo too. Father's Day and Mother's Day are their days to, to receive cards and a photo or drawing (on the card or separate) - that doesn't mean you have to see them, but it says "I accept you as members of the family even though I don't see you with the kids."
I would not invite them over. If they plan to come over to see your husband, you need enough notice to leave the house with the kids for the day - but that's kind of passive-aggressive and not so desirable. Your home is your home, not a place you have to leave. If they just show up, then you have a choice of not answering the door, or taking the kids and leaving. Or, you can allow them in IF she is sober and IF she is behaving herself - then you have to decide what to do if she starts drinking. But again, that puts you in the position of policing her.
Right now, you say that if you back down, she will not take you seriously. Then you can't do that. You absolutely must do something to say that the children will not be subjected to her unless and until she gets serious help for her drinking. That doesn't mean abstaining for the day. It means a predictable pattern of behavior, either with rehab or a significant length of time being "dry" and having her behavior calm down. You cannot take the chance of her saying something in front of the kids about her right to see them. They do NOT need to hear anything like that. So unless and until you can trust her mouth, she stays away. But the problem you have right now is that Grandpa cannot be trusted as a barometer of Grandma's sobriety. So that's why you draw the line in the sand. It would be great if your husband can support you, but if he can't, stick to your guns.
I do think Al Anon will help you find the vocabulary to deal with everyone involved. You can also get some good books in the library - you don't have to spend a lot of money on them right now, and there are plenty to choose from. It can be lonely if you are the only voice of reason. The main thing is to find a way to accept her and not her drinking behavior, to make it clear that you are not, for the time being, rejecting her but you are rejecting her behavior. Alcoholism is a family disease.
But if you don't go to Al Anon, which you do not have to do, I would not backtrack right now because it will enable her, fuel her, and let Grandpa feel he "won" by refusing to acknowledge the effect this has on you, your husband, your kids, and the family dynamic. If there is ever a reasonable discussion of these issues, you can wait for one of them to admit a problem and then say you got very upset about having this conversation, dealing with the ongoing problem, and being panicked about their safety and emotional wellbeing. Good luck and let us know how you are doing.