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Yvain comments on Rational Home Buying - Less Wrong
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Houses keep their value better than Lexuses. (Lexi. Lexoi. Lexūs. Whatever.) Eventually, you (or your heir(s)) will presumably sell the house, and then you will get more for the second house. Buying the first house gets you more liquidity than buying the second; it doesn't get you any more wealth. (If the housing market is performing well, which it did once upon a time, it may get you rather more in the long run.)
Most of this assumes you're treating your house as a place to live and not as an investment. Because you'll probably be paying interest on a mortgage, it's usually not a smart idea to pay more than you need for a house - but I admit that the possibility of selling the house later is a major factor that alters a lot of these calculations.
Since a house is inevitably both a place to live and an investment, it would seem to be appropriate to treat it as both. (Unless doing so spoils your enjoyment of it as a place to live, or something. For what it's worth, I've always thought of houses both ways, have never noticed such a negative effect, and have always been happy with the results on both counts. But I've been pretty fortunate.)
[EDITED to add: I agree that the extra mortgage interest you'll pay is a genuine extra cost -- and that, not the $35k price difference or whatever, is what you should be weighing against whatever you're paying the extra for. How the two figures relate to one another depends a lot on the mortgage interest rate, how quickly you repay, etc.]
Good point, I'll edit.