Okay peeps, listen up! iMessage is an IOS 5+ ONLY software that sends sms texts between 2 or more IDevices that BOTH have IOS 5+. It uses your cellphones internet connection to do this. If iMessage is enabled, and you send a message to another user that has IOS 5 or IOS 5.1, the message will show up on your screen colored blue instead of the usual green color of texts (Note: This is a good way to check if iMessage is working, as well as a way to check if the person you are texting has IOS 5)
Now for the perks of iMessage. When using iMessage, all texts sent using this feature are completely free through a deal Apple made with AT&T, Verizon and Sprint (Altough Sprint is like a secondary company, so if you are using google voice, and have a different number on Google Voice then your actual cell number, iMessage MIGHT be disabled) so if you bought an IPhone, and are using a SIM card from a different company, well, tough luck I guess. There IS a reason why only SOME companies sell Iphones you know.
When using iMessage, if you leave the screen on the messages app, waiting for the person to reply, it kind of has a Skype-looking feature, that whenever the person is typing, you will actually get a "dot dot dot" (...) on the bottom left, right above the keyboard.
The option in settings to send messages as SMS "when iMessage is unavailable" simply means if you are using the Sprint/Google Voice combo mentioned above, or if the person you are messaging does NOT have the IOS 5+ software (meaning they can NOT receive iMessages) then the phone will send a normal text message (carrier rates apply).
Hope this helped out. If I figure out anything else, I'll edit this later.