My own theory is that when the cult of silent hill attempted to bring their god into the world, it created a thin place in between their world and the normal one, not exactly a hole, but a place at which the divide is thinner. There are three layers to this divide, the normal hill, furthest away from the god's world, the foggy hill, and the dark hill. This other world would seem to be hell or purgatory, as that would say why some of the character's monsters are based upon their own demons, and not the demons of those used by the cult. Purgatory would also make more sense, as the hill seems to "test" the characters. If a person passes, they leave, possibly on better terms, as better people, than they arrived as, if not, the town'll either let them leave with a catch, or not let them leave at all, some characters having gone mad and presumably joined the cult, some of them simply dead, even a couple possibly having been made into monsters themselves, although I personally would like to ignore those endings as one of them depicts somebody being made into a pyramid head, which if you know what he means in the first place, is makes next to no sense.