How exactly does Enchanter Illusions work?
 

If I am a Dark Elf Enchanter and am KOS to Freeport, Felwithe, and Kaladim guards / merchants /NPCs, can I just Illusion into that specific race to go in and use their merchants, bank, walk freely through the cities?

If so, what about if I've killed their guards or other NPCs? Like for example, if I killed Felwithe guards for hours. Could I then illusion into a High Elf and go bank / sell in the same city as I was killing the guards in?

Your faction with any group is determined from the sum of five modifiers: race, deity, class, spell effects, and your history of interactions with the faction.

Of these, you can modify three of them, race with illusions, history by kiling things and doing quests, and spell effects by casting spells.

So to answer your question, maybe. The enchanter class is neutral so there won't be any modifier from that. You will get a positive modifier by being the same race, but your deity could give a negative hit you worship a evil god. This is why the standard deity advice for enchanter is to go agnostic.

If you kill enough things belonging to a certain faction though, you will eventually go KOS. As a chanter you can bump this up a little with faction spells, but not much.

One other thing, city guards, merchants and the banker aren't necessarily on the same faction, so you may be able to kill guards fine, and keep selling to the merchant.

Yep.

Faction matters for many quests, so that's another perk I suppose. I'm not familiar with these quests that enchanters can more easily do than most others. Well, except for Stein of Moggok thanks to illusions, and OT Hammer thanks to charm when that time comes.

Good point, charm is a 6th way to modify faction to amiable.

How exactly does Enchanter Illusions work?

Some think whatever it is doesn't work well enough, a tiny slice thinks it's ok as is, and the remainder are sure the spell is worse than a Hitler spongecake with Stalin icing.

Whatever it is, whoever doesn't think the same way as I do is a wrong unclassic drippy monster boy

Gross

I think you mean faction boosting spells like Alliance? Charm just turns them into your pet

And this makes them amiable to you.

You then can’t vendor or bank or gets quests from them though IIRC

It works to get the OT hammer at least...