How would you refer to an actual house that is not large? If someone said, "Dw i'n byw mewn tŷ bach," would it be clear from context, or would people snicker?
I've heard tŷ bychan used in such cases.
I think toiled / toiledau can be used to mean toilet / toilets to avoid confusion.
I assume that ty bach (small house) refers to outhouses? is there a more modern term?
that is where the word originates from but it refers to any toilet.
How do defnyddio and arfer relate? When would you use one in preference to the other? Or are they interchangeable?
They are not interchangeable. Defnyddio is to use, and arfer is like habit or routine.
Fel arfer - as usual / usually.
I know that "ystafell ymolchi" means bathroom.
Does "tŷ bach" refer to both the object and the room?
toiled refers specifically to the toilet I believe, but tŷ bach refers to both the toilet and the room. Tŷ bach also refers to an outhouse, it's pretty general.