Silent Hill 1 and 3 never happened.
If Fantasy-Harry knows all about his life before the car crash, why doesn't he instantly remember that he lives in Silent Hill, something he should know? Because for the last 18 years, he's been "in town on vacation" visiting Silent Hill, fighting demons, and saving his daughter. When the charade suddenly changes (as a result of the real Dr. Michael Kaufmann's work) he's confused because even his real life had been distorted. Cheryl has such terrible memories of Silent Hill that she denies that she and her father ever even lived there.
Dahlia wasn't just "a monster" in this game, depicted as both a slut and a pathetic senile old woman; she was turned into a monster in Cheryl's previous delusions, a cult leader who doesn't care for her daughter. That's why in Silent Hill 1, Harry's wife is almost an ideal: a woman who passed away a long time ago, with no identity. It's why Allessa Gillespie's father was never named. The idea of her loving father and terrible mother being together made no sense, so she seperated them. In her earlier delusions, Dahlia ends up dead, struck down by her own machinations; Cheryl's own desire to see her mother dead.
At the amusement park, Harry "saved" Cheryl from a dragon in the cut-out board. He tries to joke with her in flowery medieval speak about how he saved her from being "consumed" by the red horned winged beast, but Cheryl acts embarrassed and points out that it's just a painting, it's not real. But later, Cheryl herself accepts it as real. The cartoony horned winged beast becomes a much darker and twisted threat: the God of Silent Hill. Yet it's still just a paper tiger, a "painted dragon," not real.
The figures of Lisa, Kaufmann, and Cybil all stem from Cheryl's ambivalence towards the authority figures in her life: policemen, doctors, psychiatrists. They try to help her, but in the end they're just getting in the way. Lisa and Cybil may have been constructs that persisted through various states of her delusions, or were inspired by real people she knew. Kaufmann, heck, she might have just seen his name in a phonebook and found the evil doctor working with her mother to be a useful idea. Her mother is asking for a psychiatrist for her daughter? Well, those doctors must be against her too. The cops, too. They think they're doing the right thing, but they're just puppets of that horrible Dahlia.
Cheryl's own role in SH1, if it is indeed a delusion, is also telling. She "dies" and is "reborn" in a new form after Harry defeats the evil god. Of course she entered a new life: after Harry died when she was seven, her life totally changed.
SH3 may have been a more advanced stage of denial: no longer a child, she wasn't able to continue pretending that Harry was still around. So she invents a new, tragic, and heroic death for him: he was killed by the cult of Silent Hill, the symbol of her hated home (we know from her mugshot in Shattered Memories, where she's wearing clothes like Heather/Cheryl's in SH3, that she spent time away from the town) and of her mother. She personally defeats the evil this time.
At least, that's the delusion she presents to her previous psychiatrists. They indulge her, nod while she blabbers nonsense about how cultists tried to kidnap her and her father saved her from monsters. They may have suggested alternate viewpoints, which became the alternate endings of Silent Hill 1:
"Yeah, but Cheryl, your dad was still dead in that car crash wasn't he?"
"Cheryl, after defeating the god, your dad must have been abducted by aliens, right? Because that's about as believable."
"The other therapists didn't work out for you."
So the real Kaufmann takes a different tack. He focuses on Cheryl and Harry's relationship. Not on her and her father's imagined fights against evil, but her everyday life. He provokes her, cuts through the bullshit, and it shows. Her fantasy Harry grows weaker and confused as Cheryl's various delusions grow out of control and can't keep themselves straight as Kaufmann gets closer to the truth. Harry can't fight against the monsters anymore. The monsters themselves become as disjointed and irrational as Cheryl's fantasies themselves, and are revealed to be nothing but children attempting to cling to Dad like snowflakes, keep him from shattering the ice where he's been frozen in time for 18 years.