It’s easy…

1. Make a short MP3 file by ’snipping’ out the section that you want to use as your ringtone. I use an old copy of TotalRecorder
2. Convert the short MP3 to to AAC. You can do this in iTunes if you set your Preferences | General | Import Settings to AAC Encoder, add the short MP3 to your iTunes library, and then right-click on the MP3 and select Convert to AAC
3. Use Get Info to find the .m4a file that iTunes creates (it puts them in silly places) and change the extension from .m4a to .m4r
4. Copy the .m4r file into /Library/Ringtones on your iPhone using ssh/scp.
5. If it’s not loud enough, you can use mpTrim to pump up the volume of the MP3 a bit and then re-encode, etc…

I found these basic instructions very helpful in figuring this out.

Using iTunes to convert to AAC is a bit of a pain — does anyone know of a good standalone MP3->AAC converter?

Update: notes here on how to do custom SMS tones and such…