I head that RAID 0 will only use as much space as the smalles drive, forcing the 120GB down to 64. Is this true?
Correct. If you create a RAID-0 array with a 64GB drive and a 120GB drive your array's total capacity (before formatting) will be 128GB (64 x 2).
Just use the 120GB drive as your O/S drive and the 64GB as a backup/storage drive.