Kristen Parker waits for her mother, Elaine, to return home and stays awake by making a papier mâché house. Kristen falls asleep but “awakens” in front of a boarded-up house just like her model. She follows a girl inside where Freddy Krueger, a man with a finger-knives glove, almost catches her before she screams herself awake. In her bathroom, Kristen sees Freddy in the mirror as the cold water handle grabs her arm while the hot water handle sprouts knives and slices her wrist. Elaine finds Kristen holding a razor, having apparently slit her wrist. At the psychiatric hospital, Dr. Elizabeth Simms tells Dr. Neil Gordon about Nancy Thompson, a new staff member who specializes in nightmares. They are interrupted when Kristen becomes hysterical but Nancy arrives and calms her. Neil tells Nancy about teen patients at the hospital who have various sleep disorders but share a nightmare about a boogeyman. When Nancy drops her purse, Neil is surprised to see prescription Hypnocil pills. Max, an attendant, gives Nancy a tour of the facility and introduces her to Phillip, who makes puppets, and Kincaid. Nancy goes to Kristen’s home to pick up her suitcase and the papier mâché house. Neil discovers Hypnocil is an experimental drug to suppress night terrors. Kristen falls asleep and finds herself back inside the boarded-up house as a giant snake-like Freddy attacks. Kristen screams for Nancy and pulls her into the dream. When Nancy stabs the snake-like Freddy, he recognizes her and Nancy tells Kristen to get them out of the dream. The next morning, Nancy confirms that Freddy is real and Kristen’s papier mâché model is of Nancy’s Elm Street home. At group therapy, Neil and Simms introduce Nancy to the rest of the teenage patients: Will, in a wheelchair after a jump; Jennifer, who wants to be a TV actress; Joey, who does not speak; and Taryn, a former drug addict. Nancy tells Neil that the teens are in physical danger from their dreams and he should prescribe Hypnocil, but he refuses. That night, Phillip is asleep when his marionette morphs into Freddy and slices Phillip’s arms and legs, grabs the veins and uses them to control Phillip like a puppet. Freddy forces Phillip to a rooftop and the other teens watch helplessly as Freddy drops Phillip to his death. Simms wants to sedate everyone but Nancy argues they would be defenseless against their dreams. Simms is surprised when Neil prescribes Hypnocil. One night, Jennifer watches television to stay awake but Freddy emerges from the television and smashes Jennifer’s head into the screen. At Jennifer’s funeral, Sister Mary Helena approaches Neil and says that the teens can be saved if the unquiet spirit is buried. Nancy and Neil lead an unofficial group session where Nancy tells the teens about Fred Krueger, a child murderer who was burned alive by the Elm Street parents. Six years ago, Freddy murdered Nancy’s friends in their dreams and almost killed her. These teens are the last of the Elm Street children. Kristen can pull them into her dream and, if they each use a special power from their favorite dream, they can defeat Freddy. Neil tries group hypnosis but it doesn’t seem to work. Nancy wants to try again but Neil disagrees. Joey sees Marcie, a sexy nurse, in the hallway and follows her. In the room, balls suddenly float and everyone realizes they are dreaming. The teens have special dream powers: Will has regained the ability to walk and is a Wizard Master; Kristen does gymnastic moves; Kincaid bends metal; and Taryn is deadly with switchblades. In a bedroom down the hall, Marcie undresses and, as she kisses Joey, she pulls his tongue out. He tries to hold onto it, but the tongue flies out of his mouth and ties his arm to the bed. Another tongue flies out of her mouth and ties his other arm. Freddy appears and completely “tongue-ties” Joey to the bed. The mattress drops away, revealing a hellish pit below. He tries to scream but cannot. In the group room, lights explode and the walls close in. The door suddenly opens and Simms enters to find everyone asleep and Joey collapsed in a coma. Neil and Nancy are fired but, as Neil leaves, he sees Sister Mary Helena in an abandoned ward where the criminally insane were kept until the 1940s when a girl on staff was accidentally locked inside. The girl, Amanda Krueger, was raped by the inmates and her son, Freddy, was deemed “the bastard son of a hundred maniacs.” Freddy was murdered but no body was found. Sister Mary Helena tells Neil to find Freddy’s remains and bury him in hallowed ground. When Neil tells Nancy about the nun’s story, Nancy reveals that her father hid Freddy’s remains; however, her father, Thompson, refuses to help. Hearing that Kristen was sedated and needs help, Nancy goes to the hospital while Neil forces Thompson to take him to the auto salvage yard where Freddy’s bones are hidden. Max refuses to let Nancy see Kristen but lets her visit the others. Nancy tries group hypnosis again and puts the teens in Kristen’s dream. Freddy’s knives suddenly slash the walls and Kristen is back in her bedroom as her mother returns home. Elaine’s date, however, is Freddy, and Kristen barely escapes after he cuts off her mother’s head. When Taryn finds herself in a dark alley with Freddy, she pulls out her switchblades but Freddy’s fingers turn into syringes and he overdoses her. Freddy sends a barbaric wheelchair after Will, who summons his wizard powers to destroy it. Will turns his wizardry on Freddy but he is overpowered by Freddy and dies. Nancy, Kristen and Kincaid meet at a doorway that leads them to a boiler room. Meanwhile, Neil and Thompson reach the Cadillac where Freddy’s body lies. In the boiler room, Joey is strapped over a fiery pit as Freddy slices him free, and Nancy reaches Joey just as Freddy cuts the last tongue. She grabs Joey’s hand and Kincaid pulls them up while Kristen distracts Freddy. He’s about to kill Kristen when Kincaid knocks him back with a pipe. Freddy strangles Kincaid until Nancy stabs Freddy with a metal pole. Freddy laughs as he pulls the pole out and reveals the souls of children trapped in his body, fueling his strength. Freddy suddenly vanishes from the boiler room as Neil and Thompson bury his body in the salvage yard. Freddy’s skeleton arises, kills Thompson and knocks Neil into the grave. Nancy, Kristen, Kincaid, and Joey find themselves in a mirrored hallway. Freddy appears in every mirror and the various images grab Nancy, Kristen and Kincaid but Joey uses his dream power to scream and break the mirrors. A shower of light descends and Thompson’s spirit appears. Nancy hugs her father, but it is actually Freddy and he stabs her. Freddy turns on Kristen but Nancy stabs him with his own knives. In the salvage yard, Neil sprinkles holy water on Freddy’s bones and, in the room, Freddy’s body disappears with a flash. Nancy dies in Kristen’s arms. At Nancy’s funeral, Neil sees the nun in the distance. She disappears but he discovers the grave of Amanda Krueger who later became Sister Mary Helena. Later, Neil has the papier mâché house by his bed and, as he falls asleep, a light goes on in its window.