Hi Kelti.
DXTbmp doesn't have to use MSPaint (which is an awful graphics program). It just defaults to it in case you don't have any other painting program. Use GIMP, Paint Shop Pro or Photoshop and option DXTbmp to use that as its default and the effect you are describing will not be there.
DXT1 has the greatest compression and therefore the most loss of detail. DXT3 is a compression algorithm but it isn't nearly as drastic and preserves most of the detail. 565 uses creates files 4 time larger than DXT3 so of course it has more detail, but you sacrifice any transparency areas because it doesn't use the alpha channel which means no damage textures. For my money, other than prop textures, DXT3 is the best compromise.
Just my preference, 2 cents, etc.
Hi Captain Kurt!
Obviously so, MS Paint is a Jurassic graphics program, if not worse. Mine was only an example for highpockets, so that he could open a DXT1/3 file and see what happened. Trying to modify a texture it's an entire different ball game and MS Paint is a real hog when it comes to blending paints and so on, while layering doesn't even exist!
Although you might be surprised at all the things I was able to get out it, since I never had the physical time to study more complex, professional applications like Corel Draw, PSP or Photoshop.
My entire series of Pearl Harbour Japanese repaints for stockers
(which I have plans to expand in the future with some new "eye candies") was done with copy and paste actions in MS Paint!
When I claimed in my readmes that I cleaned up most the "colour bleed" effect, I assure you I did it by copying a pixel of "good" paint and pouring it in the offended areas with the bucket and the pencil tools. The results were quite good. In the same way, I did all of my de-mirrored repaints for the overhauled stockers.
Then, I saved the textures everytime in 565 format. Since those were jobs that went on for quite a time, the times I saved my work were many, but I never lost the tiniest detail. I did the same job on the damage textures, by pasting the bullet holes and ripped parts copied from the stock textures over a copy of the good primary texture.
Next step, I extracted the stock alpha channel, transparent damage texture with DXTbmp. The very last time, I saved it only once together with the finished damage texture in 555-1 format (which bleeds colours just like DXT1/3), obtaining the complete damage texture file with its proper transparent areas where combat damage occurred.
This is how I did my last stocker repaint, OH B-24D "Hail Columbia".
All of the above goes also to demonstrate what I discovered since the very beginning of my modest involvement with repaints: it's not the capability level of the graphic program used that "bleeds" the paint, but saving a given texture in compressed format. Every new save worsens the problem, while I saved countless times the same texture in plain *.bmp format with stone-age MS Paint and I never lost a single pixel of colour.
Even virgin, off-the-shelf CFS2 stock liveries show a certain degree of bleeding damage caused by their DXT1 compressed format.
With all of it said, I
you and all of the fine repainters who presented us with splendid, realistic aircraft, ship, vehicle and assorted CFS2 object textures, as
I know what it means tackling a repaint!
Cheers!
KH 
Actually kidding aside go here; http://www.mwgfx.co.uk/ and get the BXT utility. and we will begin from there. I have a instruction around here somewhere about the steps to take that will clarify the texs. Maybe someone else here remembers it off hand.
I would not know how to change any of them to one of the other (DXT1,565 or DXT3) anyway.
