Definition: Hallucinations are sensory experiences without sensory stimulus; in other words, you see (visual hallucinations), hear (auditory hallucinations), or feel (tactile hallucinations) things that aren't really there. In people who have hallucinations due to psychosis, auditory hallucinations are the most common.
Hallucinations are, by definition, vivid, realistic, and inseparable from perceived reality. That's what makes them so difficult to deal with—we all would like to believe that we would be able to tell the difference.
Though hallucinations are most often associated with schizophrenia, not everyone who has schizophrenia hears voices, and some people with disorders or problems other than schizophrenia do. For example, auditory hallucinations can be caused by bipolar disorder (manic depression), epileptic seizures 
, or drug use. In some cases, like those few seconds that you're falling asleep (hypnagogic hallucinations ) and the few seconds you're waking up (hypnopompic hallucinations ), auditory hallucinations are actually normal. They're also common if you stay awake too long (i.e. over 100 hours). It's like your brain needs to dream, so it starts while you're still awake.
You can read a first-hand account of hallucinations with schizophrenia to learn more about what it's like.