Some of my settings are based on real places, but sometimes I change the names. In two cases, I wanted authentic croft names, but not actual croft names (i.e. houses in which people might actually be living).
The solution manifested itself by luck when I happened upon an old parish map hanging on the wall of a local pub. From that I was able to identify a number of derelict crofts, and thus select genuine-sounding names (for they were indeed genuine) without fear of upsetting anyone.
For villages and towns and cities, I generally use real names, except in the case of one particular town – which had absolutely nothing to recommend it – for which I fabricated a name, although I don't really know why.
Do you pluck your setting(s) out of your imagination, or use real places? Or both? Do you use real names too? If not, how do you go about making them up?