SH2's story about euthanasia/mercy killing and the meaning of that loss was amazing and it was essentially a well written character story. Everything in that game has a psychological meaning from James' perspective and possibly exists mostly in his mind (something the game enforces in character interactions). In comparison, SH3 was full of occultist mumbo jumbo and the story was pretty conventional IMHO.
It's not in his head. It is influenced by his psyche though. The entire deal with Silent Hill is explained in detail in the first game. 'A persons nightmarish delusions come to life'. SH makes reality maleable and dreamlike, influenced by the mind of people teetering on the edge of insanity. Reality pretty much works like a dream at that point for people that are affected by SH, hence 'nightmare' sequences. Note: operates like a dream, not literally a dream.
Otherwise it's normal town with normal people living in it, the only way people not fucked in the head get affected by SH is if they get dragged into it by people that are. The town isn't willing or evil or anything, it just latches onto people like that due to the events of SH1 with Alessa, she basically corrupted the nondescript power that was in the town. Hence why having prequels and mythology prior to SH1 is a complete story annihilating fuck up made by the western developers who it seems like don't even know the basic plot of the first damn game.
Now with this groundwork laid, you should take another look at SH3. The occultist shit, that's the drapes, which is to be fair a lot of neat detail put into the religous sect and themes, but the primary driving force of SH3 is Claudia. She's a crazed religious zealot, and the town latched onto her insanity, but this resulted in her being empowered by the town, and it made her interpretation of her own religion manifest in reality. Meaning
the occult stuff is not real in SH. It only exists due to Claudia's belief in it. Hence why Vincent's plan failed. She doesn't believe in that part, so it doesn't have power. How's that for a twist? Btw, this is almost the exact same case with Walter in 4, only that takes it even further, in that he believes this religious sacrament will get him what he wants, with no real belief in the religion itself, and that's the only reason why it works. Hell, he kills himself in prison, but because he believes that he will continue to exist, he continues to exist thanks to the power of SH. Alessa is much the same in SH1, she believes wholeheartedly in the religion as dictated by her mother. It's why Dahlia is able to get away with so much.
The games with the cult are a lot closer to SH2 than people give them credit for. Or rather, all the games made by Team Silent operate on the same basic understanding of how SH works, as laid down by the first game.