How can I save form data as an XML file

Currently when I submit a form the contents are saved in a text file
Ex. Data1 : Data2

Would have have to create a custom process to handle the save function?

You are going to need to write a custom plugin with a custom form process that can save as XML data. Examples of how to write a custom form process can be found in Email plugin, Slack-Invite, SweetCapatcha, etc.