The German word for “imagination” (in the sense of forming images in your mind) is “Phantasie” (f.), also spelled “Fantasie” (originating in the Greek “phantos” for “visible”):

– “Seiner Fantasie waren keine Grenzen gesetzt.” – “His imagination knew no limits.”
– “Dass du es schaffst ist pure Fantasie!” – “That you will succeed is pure fantasy!”

An “illusion” (in the sense of a false or misleading mental image) is either “Illusion” (f.) or “Einbildung” (f.).

Note: The action of imagining something is “sich etwas vorstellen” in German:

– “Stell dir vor du wärst ein Millionär!” – “Imagine you were a millionaire!”
– “Ich kann mir das nicht vorstellen.” – “I can’t imagine that.”