I am almost certain that is not the way it is done it professional games. I noticed that in morrowind it is very clear (to me) that the head, hair, armour and clothing are seperate objects and it would be possible to use an external modeller(Blender, for example) to give the same bones animation to many different clothes and armour, so they would perfectly fit around the player. As for the changing of type of clothes, face, etc. it is the same model, just with a different texture. It's not easy, certainly, but that is what making an RPG would involve.