While the first three "Silent Hill" games are fairly consistent, the fourth one changes things a bit due to the nature of portals to different parts of the game's worlds and the introduction of Walter Sullivan's Ritual story, and then the later western-developed games also add new things (and even retroactively alter story bits of previous games,) so I'll just try to cover the first three games.
Firstly, the BASIC LORE, since I'm not going to put everything (might as well play the games and read the official books for that.) I'll also try not to spoil the actual games' events beyond basics:
- Pre-1600's: the land of Silent Hill before the town's founding is sacred ground for rituals performed by Native Americans
- Late 1600's: European settlers arrive in Massachusetts; witch trials and shit
- 1700's: mysterious epidemic breaks out, and the town is essentially now dead
- 1810's: War of 1812 begins; Silent Hill becomes penal colony, prison and hospital are founded
- 1830's: forced removal policy of Native Americans in North America starts
- 1850's: coal mine found, town revitalized
- 1860's: Toluca prison camp for Civil War POW's constructed
- Later 1860's: prison camp converted into federal prison after Civil War
- 1890's: Native Americans end organized resistance; people all over Silent Hill disappear
- Early 1900's: Silent Hill becomes tourist town, Toluca Prison closes; the primary cult begins formation*
- 1939: "strange events" at Toluca Lake
- 1963: Silent Hill's mayor dies suddenly, followed by the rest of the town's staff
- 1969: Alessa Gillespie is born
- 1976: Dahlia Gillespie enacts her ritual to summon the town cult's god; Cheryl is born
- 1983(?): "Silent Hill 1" occurs (monsters appearing, confirming magic now taking effect)
- 1993(?): "Silent Hill 2" occurs
- 2000(?): "Silent Hill 3" occurs (confirmed about 17-18 years after "Silent Hill 1")
We DO have enough information to know that the foggy and creepy version of Silent Hill with monsters began as early as sometime in the 1980's (the first game.) But the events of that game occur in what's called Old Silent Hill, which is apparently ignored by vacationers. Laura and Mary meet a year before "Silent Hill 2," so apparently the resort part of town was still normal for them in the early 1990's, and some people still lived there. The two parts are separated by Toluca Lake.
What one can infer from this info is that Old Silent Hill was abandoned as of the 1980's following Dahlia's ritual, while the vacation town was still relatively normal until the events of "Silent Hill 2." Whether people lived in those parts after is not really known, though I personally don't believe people did.
Basically, the town of Silent Hill holds some dark magic due to pissed off Native American rituals combining with the rituals performed by the cult trying to rebirth a god and create a paradise by destroying humanity and, in the cult's eyes, their pain and suffering as well. This is mostly explained in "Silent Hill 3."
The Otherworld is where the real world seems to intersect with "unreality" (magic and traumatic experiences and such, like what was undergone by the Native Americans who originally inhabited the area, Alessa, James, and Angela, to name a few.) There's not yet a specific confirmed way that the Otherworld manifests, though it usually becomes more and more prominent in a game as characters learn more and more about the reasons they've been brought there.
And contrary to how every game past "Silent Hill 4" has attempted to make the town into basically a demonic psychiatrist, "Silent Hill 2" is the ONLY game in the original four games that based its horror on what the main character (James Sunderland) had been experiencing. Harry Mason, Heather Mason, and Henry Townsend all are witnesses to the experiences of other people.
TL;DR: there is a lot of dark magic in Silent Hill created from rituals as early as the 17th century that draws people who are usually explicitly tied to Silent Hill in some way to the town (read: NOT JUST ANYONE WITH PSYCHOLOGICAL ISSUES.) However, not everyone who comes to the town has history with it. The magic of Silent Hill seems to feed off of traumatic events and gets stronger as the characters understand more about why they're in the town. There isn't enough information to confirm whether or not normal people still live in the town (either Old Silent Hill or the resort part) after the 1980's, but I make the assumption that they don't.
Let me know if any of you guys have questions. Most of my information is parsed from having played the "Silent Hill" games developed by members of Team Silent of Konami Computer Entertainment Tokyo firsthand (1, 2, 3, and 4, to be specific,) reading up on the excellent fan site Translated Memories, which compiles translations of official Japanese documents detailing the first four games of the series, and a little bit of personal interpretation, as much of the lore has never been completely explained.