Well, when you are upgrading your 360 HDD the cheap mans way, you can either only get a 20GB, 60GB, 120GB, or a 250GB (not sure if the file for this one is available yet). For example, when if you get an 160GB, you can only either use 20GB, 60GB, or 120GB, and not 250GB, and if you chose the 120GB, then you lose 40GB (HDD size wise). You have to do this or the 360 won't recognize your HDD, and if you are the only person with an 160GB HDD installed on the 360, then I'm pretty MS sure will ban you.
I did it, I took my old WD Scorpio 160GB and changed it to an 120GB, took my 20GB out, and installed my new 120GB in. All worked, and I still continue to play Xbox Live. I'm sure a lot of people did it too, and I haven't heard any complaints. Also, FYI, I am running an non-modded 360 if that makes a difference.