This is set 10 years after the events of the first Silent Hill game, sometime in 1993.
James Sunderland has arrived in the town of Silent Hill after receiving a letter from his recently deceased wife, Mary Shepherd-Sunderland, despite the fact that she had died from a chronic disease three years ago. The letter states that Mary is waiting for James in their "special place", which confuses James, as the whole town of Silent Hill was their "special place". After leaving the observation deck and traveling toward Silent Hill, James comes across the Toluca Graveyard and meets Angela Orosco, a teenage girl who came to the town to search for her mother. When James reaches Silent Hill he discovers that it is not the same, beautiful town as it was in the past. In addition to the bizarre, omnipresent Fog World, the whole town seems to be rotting away and abandoned. Macabre, vaguely humanoid creatures are roaming the streets and attempting to attack James whenever possible. When he discovers that the path to his first destination, the lakeside Rosewater Park, is cut off, James decides to travel through Woodside Apartments to reach what he believes could be the "special place" Mary mentioned briefly her letter.
Once inside the apartments, James briefly encounters a little girl named Laura who tramps on his hand before scurrying away. Soon after that, he comes across Pyramid Head, a humanoid monster whose head is completely obscured by a giant, metal, pyramid-shaped helmet that protects him against anything James will possess in his arsenal. James later meets an obese young man, Eddie Dombrowski, while he is vomiting into one of the apartment toilets. Eddie responds in a very defensive manner to questions regarding a corpse in the refrigerator of the apartment room. James finds Angela again, contemplating suicide with a knife in her hand, while lying in front of a large mirror. James persuades her to hand him the knife for her own safety, after which she flees in an unusual panic.
When James finally reaches Rosewater Park he meets a woman named Maria, who appears nearly identical to his recently deceased wife Mary, but clothed in a more provocative outfit and possessing more of an impudent attitude. During their travels, she reveals insight into matters that only he or Mary would know, and acts in a very seductive manner toward James. Maria accompanies James in his attempt to reach his second suspected "special place," the Lakeview Hotel. James enters Pete's Bowl-O-Rama where he meets Eddie again. He also spots the little girl, who runs away from James upon seeing him. Eddie then reveals to James that her name is Laura. Outside, Maria claims to have seen Laura and, out of concern for her, has James try to pursue the child. Their search leads them to Brookhaven Hospital, where Maria then becomes sick, and insists on resting in one of the hospital rooms.
James finds Laura in one of the rooms, but becomes angry at her for claiming to have known Mary for the past year, in clear contradiction to his belief that she has been dead for three years. Laura responds by locking him in a room filled with covered monsters stuffed in hanging cages (the Flesh Lips), under the pretense of looking for a letter from his wife. After they are defeated, the hospital undergoes a sudden dramatic change to the Otherworld, where James returns to the hospital room to find Maria missing. James later finds Maria in the hospital's basement, however, Maria becomes angry, claiming that James had abandoned her. After she calms down, they press on to find Laura. Pyramid Head again appears and chases both James and Maria through the hospital's basement. Pyramid Head manages to slaughter Maria while they attempt to make their escape via an elevator. Alone again and saddened by the loss of Maria, James decides to refocus on his original task of finding Mary. He leaves the hospital and finds a key buried beneath a statue in Rosewater Park, which leads him to the Silent Hill Historical Society.
The Historical Society becomes an exploration of two levels not noted on the town map: Toluca Prison and a labyrinth in which Pyramid Head resides. In this area, James finds Maria, miraculously alive and locked in a prison cell, who greets him with memories of Mary. He tells her that he will free her, but upon leaving and later coming back and entering the cell, James discovers that she has been murdered once again. The next area, in which James reunites with Angela, provides back story as to why Angela and Eddie are in the town. A newspaper clipping indicates that Angela killed her father, Thomas Orosco, who abused her with the complicity of her mother. James saves Angela from a monstrous representation of her father (absract daddy), but she then becomes hostile towards James. Eddie is revealed to have snapped after years of verbal abuse by his peers. He killed the dog of a football player and then shot the dog's owner in the leg. It becomes clear that upon his arrival in Silent Hill, he has gone insane, seeing everyone as making fun of him, and has resorted to killing anyone he encounters. He first attempts to explain the path of bodies he has left during his time in Silent Hill, but ultimately turns on James as well, and must be killed to progress through the game. James feels ashamed for killing Eddie, and after this point, James questions his perception of the events leading to his arrival in the town. As well, the letter that he supposedly received from Mary goes blank, indicating that the letter itself was something that James himself made up, and that it never actually existed in the first place.
James exits the labyrinth and takes a boat to the Lakeview Hotel in hopes of finding Mary. Once there, he finds Laura once again, and she gives him the letter she claimed to be seeking earlier, which reveals that Mary wanted to adopt her while confirming Laura's claims of knowing Mary for the past year. The final truth is shown to James when he watches a video tape he apparently left at the hotel three years ago, which shows that he killed his terminally ill wife by smothering her with a pillow. Laura, who is ready to leave the town, finds James and he chooses to reveal the truth to Laura. Laura becomes angry with him for killing Mary, then silently exits the room. The radio James has been carrying to warn him of the approach of monsters then sends a message from Mary, asking him to find her. James explores the rest of the hotel, discovering that it is decrepit and rotting, and has appeared to be nothing more than the remains of a building that has previously experienced a fire. James then finds Angela on a burning staircase, and she asks him to return her knife so that she can commit suicide. James declines. As Angela retreats up the burning staircase, James states that the room is hot as hell, to which she replies that "it's always like this for me", meaning that her life was always a living hell. She then completely ascends up the staircase, and disappears into the flames.
The climax approaches as James finds yet another resurrected Maria, bound and screaming for James's help, but is promptly killed by two Pyramid Head monsters. James then realizes that they have been created to punish him for his sins, and fights the two Pyramid Heads. After they are severely weakened, they commit ritual suicide with their own spears as if to indicate that their purpose has been fulfilled. James is led to a hallway where he listens to a previous conversation that he and Mary had while she was still alive; in this conversation, James brought Mary some flowers, but she did not accept them, stating that she is too disgusting to deserve flowers and yells furiously at James. At the end of this conversation, Mary desperately pleads to James for him to be with her. James then enters a large metallic complex with a long staircase. At the top of this staircase, he finds a woman (depending on the ending, the woman will be either Maria or Mary herself) who transforms into the manifested pain of Mary. After James defeats this final demon, the game comes to a close.