Lying Friend

Hi, my housemate is great, she's so much fun and caring and nice.
I really like her but there's a big problem: She lies, she lies about everything.

She's from a different city, a 'ghetto' where there are loads of problems and shootings. Her family have nothing at all to do with this. But she pretends that they do, and that she is a very important person (i.e. She's often met Bill Clinton, Tony Blair, and even Bob Geldof to try to sort out such problems with her area).
I've met her family and I have since met a few other ppl from her area who were pretty confused by her untrue claims (I didn't specifically tell anyone that she has a problem, I just said that I must have misunderstood when they contradicted stuff I asked them about).

I believed her for three years, but now the lies are just getting too big and obvious (her best friend is an old millionare who was wrongfully imprisoned, her boyfriend who she loved was shot dead, her current fiance bought her grandparents a house in the country, etc.) This fiance doesn't exist, neither do anyone else in her made-up life that she expects me and our circle of friends to believe.

She's a final year psychology student so she must know she's got a mental problem. She must know. I used to get very annoyed with her because I thought she thought I was completely stupid, and that's why she told me them, but she does it to everyone.
She goes home for a weekend and comes back to uni with wild stories about her life at home (e.g. a tank drove her home coz there was a traffic jam).
I can't live with her for the Summer even though I know she wants us to move in together. None of our friends can handle living with her either. The girls she lived with last year definitely don't want to live with her again.

I love her to pieces but I just can't put up with her. I don't know what she will do if she has nobody, im afraid she'll get worse and worse.
Sometimes for a few days in a row she won't mention any of this and I can almost forget how much it bothers me, but then she says something to remind me of it all and I just get so angry that I can't even stand to be in the same room as her.

Why is she like this? It must be a psychological disorder. Will it get worse? Can it get better?

I am never going to confront her with my suspicions (OK, I mean knowledge) that she isn't telling the truth, neither will any of our friends. If I did say something, I'd be afraid that she would get so embarrassed that she would leave the city completely (She is an EXTREMELY proud person) and that involves all of us losing a good friend, and her having nobody at all.
A girl I met from her area who went to school with her said that nobody likes her from there and she doesnt have any friends at all at home. I don't want her to go bck to such a lonely existance.
Honestly, she's great, just weird.
Help me please!!