I think you are referring to a hack commonly known as "Apps-to-SD" (a.k.a. "apps2sd" or "a2sd" on some forums). This is where you re-partition your SD Card to have an Ext2/3/4 partition after the main Fat32 one, and then use a custom ROM/kernel combination that allow moving certain parts of OS to that partition. Namely, all 3rd-party downloaded apps, phone's cache, and in some cases app data and dalvik-cache.
Also keep in mind that as with all custom ROMs and kernels, this needs to be built for a specific device, so you will need to find a ROM with built-in Apps-to-SD support for your specific handset.
This trick does free up a portion of internal memory for use as RAM. However, as with most such solutions there are many cons to be aware of.
- SD Card needs to be re-partitioned in a very particular way (data will be lost during partitioning, so back it up.)
- Speed rating of the SD Card will play a large role in the system's overall performance and stability. Slower cards will cause delays in apps starting up, for example.
- The phone will not be able to function if you remove the SD Card, since the 2nd ext partition is now used by the phone as if it was part of its internal memory.
- Extra wear and tear on the SD Card from excessive writes. Unlike the EPROM in Flash memory, the SD Cards aren't really designed for many write cycles, so as time goes on you will find the card wearing out sooner than usual.
- Device will not be as stable. You may see ANR (application not responding) messages more often, as even the fastest SD Cards are still much slower than the internal flash memory.
- Data corruption on the SD Card is a real issue, and can render your phone inoperable, requiring a complete re-flashing of the ROM and loss of all data. So have recent backups always, and preferably not on the SD Card itself.