The difference between the sku's is all about HD size and some extras. I'd heartily recommend at least the 20giger, even a free silver account will net you truckload of demos, access to the marketplace and messaging - and you'll need storage. As a bonus, it comes with the headset and HD cables (component, if you want HDMI that's a side buy).
As for the games, there's a truckload to chose from and it'll depend a lot on your tastes but I'd personally advice you to check out Bioshock and Pacman CE (this one's downloadable from the marketplace).
As for Forza 2... I do own it (and played the heck out of it). The gameplay is insanely good (for various reasons it'd take too long to explain) and the online excellent. However, the whole game might feel a bit dry (it all goes from menus to the racing line and back to menus). Also, graphically it's a notch below pgr4, gt5p, grid, etc... albeit the real time reflections are jaw-droppingly awesome (and resource intensive, no other game features something like that).
edit: if you can tolerate graphical glitches, Mass Effect is one hell of a game.