It has been five years since Nancy Thompson waged her last battle with Freddy Krueger in that sinister house on Elm Street.
The Walsh family- Jesse, a seventeen year old with his father, mother and sister, Angela- has just moved in. Right off the top Jesse starts having bad dreams. His parents assume this is due to the pressure of being the "new kid in town." Jesse knows otherwise. Somthing evil is alive in this house.
The signs are clear but disturbing. The house becomes unbearably hot suddenly on one of the coolest nights of the year. Appliances take on a mentality of their own, and abruptly burst into flames. The pet parakeet has an anxiety attack and turns into a roman candle.
Jesse turns to Lisa, his new girlfriend, to try and figure out what's happening. They piece together assorted rumours and old newspaper clippings of the house's homicidal past, and discover the grisly details about the local child-murderer Freddy Krueger, who was burned to death by town citizens years ago.
Meanwhile, Jesse's dreams are turning frighteningly real, and perhaps blurring into reality itself. Freddy Krueger appears in the darkness, muttering black threats about the "plans" he has for Jesse. Lisa tells Jesse that he's just having a series of intense psychic episodes, but something tells him the situation is far more odious. Slowly, he feels himself succumbing to Freddy, and his own darker impulses rising within.
In a bloody nightmare, Jesse finds himself observing the brutal slaying of his gym teacher, Coach Schneider. The next day, he learns that the murder has, in fact, occured. Jesse is convinced that it wasn't Freddy Krueger but himself who was the murderer. The fear starts to build inside Jesse like never before. He feels his sanity starting to unhinge.
Panic-stricken, Jesse cuts himself off from his family and friends. But Lisa seeks him out and refuses to leave, comforting him. Jesse begins to relax. They start to make love when, abruptly, Freddy siezes hold of Jesse: a long-tongued demon is suddenly staring hungrily at Lisa. Fearing for her, Jesse tears imself away and runs outside, leaving Lisa in tears.
Jesse visits his old friend, Grady, and begs him to stay awake with him. He tries to tell Grady about Freddy's possession of his body, but his friend shrugs and dozes off. Soon after, Jesse doubles over in terrible pain, and Grady wakes up to see him being ripped apart by a savage force: a beast within, Freddy Krueger, clawing it's way out. The glistening killer emerges and eyes Grady. Grady screams and tries to run out of the room. The door is locked. Freddy reaches out and, within seconds, Grady slumps to the floor, blank-eyed, wasted. And there, standing over Grady's body, is Jesse.
He finds Lisa and falls into her arms, bloody and agonizing over Grady's murder. Lisa listens with numbing realisation: these aren't just dreams, and Freddy is no shadow. As Jesse feels another transformation coming on, he warns Lisa to run away. But she stands by, trying to help him fight it. Still, Freddy wins out.
Freddy attacks Lisa and begins chasing her through the house. In his clutches, Lisa begs for her life and pleads with Jesse to come through. Poised for the kill, Freddy is about to slash at her....when something stops him. A glint of recognition in his eyes, his features contorting into confusion. Freddy screams out and runs away from Lisa and into the night.
A rampage of terror follows. Freddy invades a pool party, boils the pool water and spreads flames everywhere, slashing at random at the young party guests. Lisa's father attempts to fire at Freddy with a shoutgun but Lisa, knowing it is really Jesse, stops him. Freddy turns and stalks away, right through a hedge fence.
Lisa runs to the old power plant where Krueger used to work, thinking she might save Jesse there. She finds him and tells him that she loves him and that he can fight from the inside. She then removes Freddy's hat and kisses him. Freddy begins to lose control and begins to weaken, as Jesse feels an inner strength of his own welling inside him. As the power plant begins to burn to the ground, Freddy himself starts burning and finally gives up his possession of Jesse's body. After he dies, the rest of the power plant suddenly extinguishes. Just when Lisa thinks it is all over, Freddy's burnt corpse begins to move and Jesse crawls out of Freddy's ashes. The horror is over, not with a bang but with a whisper.
The following Monday, Jesse goes back to school. He climbs the bus, finally relieved that it is all over. When the bus begins traveling too fast, Jesse panics and jumps up, only to find out there is nothing wrong; the bus is coming to its regular stop. As he and Lisa rest at ease, Freddy's glove bursts through their friend Kerry's chest and the bus speeds off the main road and into the open land, just like in Jesse's nightmares.... Freddy is back again!