rxl125,
I have been experiencing exactly the same issues as you. I have an XT, which I love. I started doing a few shoots for friends, and started getting paid for it, so I thought I better have a second camera "on the job." I got the XTi, and loved it even more than the XT....*except* for that nagging lockup/busy issue using the internal flash. I have an external flash, so I figured that would be that, but sometimes I just like to take my camera with me to snap some photos of my kids, etc., and the external flash is a bit bulky...
Canon support told me it was designed to work that way, I tried to explain to them that the XT did not have that "feature," but got nowhere.
I updated my firmware this evening to 1.1.1, to see if maybe they fixed the problem without really admitting it was a problem, but got the same issue. Then, for no real reason, I flipped the flash back down, then pressed the shutter release, and the camera instantly flashed and took the picture! I just finished taking 117 pictures in rapid succession, with the internal flash, by flipping the flash arm closed immediately after each picture. The flash seemed equally bright each time, and took no longer to operate than the first 15 photographs (before it started locking up).
Not an ideal workaround, but it has given me new hope to keep this model (I was contemplating selling it and buying another XT).
Hope this helps.