1.) The dead guy in the bathroom stall is COLIN. Colin is the janitor who raped Alessa, and that stall is where the rape took place.
2.) When the bathroom melts into the hell universe and the creepy dude with his feet on his head comes crawling out of the stall, that is also COLIN. It's the same pose he's in in the bathroom stall.
3.) The identity of Pyramid Head (the dude with the huge knife) I didn't catch until the credits, but that was also COLIN.
This really leads me to believe that this is a dimension that was created by the fear, pain, and hatred that Alessa has/had, and has sucked in the spirits of the dead that were actually killed in the fire. Of course, that would actually mean that Alessa did have some kind of powers, so her being branded as a Witch or Demon may not have been entirely wrong.
Fun, that. And very Japanese.
At the end when Alessa has destroyed all of the churchfolk, she enters the little girl because that means that she has a chance to have a "normal" mommy, so she "keeps" Rose.
Then there's the thing about the sign.
In the early part of the movie, Rose and Sharon fall asleep under a tree. They wake up, and as they walk back to the car, there is a sign shaped like an open book with some religious sayings on it. To me, this indicates that it's close to home which is somewhere in ohio, several hours away from Silent Hill.
However, when the cops bring the father back from the orphanage and drop him off, they drop him off at this same sign. It seems odd that they would drive him that far, so this I'll mark down as anomaly #1.
Then there is the part where Rose gets pulled over by the cop, and the road sign shows the road to Silent Hill peeling off to the left, it also shows Brahms as being straight ahead, when Rose had already just left the Brahms gas station.
The anomalies could just be editing boofs, where the sequence was reordered to help tell the story better, or they could be intentional, which would indicate to me that even that world was something that was imagined.
In the end, I don't think it matters. The story is the ride.