The story begins with a young girl, Kristen Parker, creating a papier Mache model of 1428 Elm Street. The house, originally inhabited by Nancy and Jesse from the preceding Nightmare on Elm Street movies has been haunting her dreams. As she works Kristen blasts loud music, eats coffee from the jar and swigs Cola in an attempt to stay awake.
Kristen's mother bursts in, annoyed that her daughter is still awake and reveals that Kristen has been seeing a therapist for her nightmares. Mum is accompanied by a guy she has met and is in a hurry to return to him. She tucks Kristen in and goes downstairs leaving Kristen to fall asleep.
Kristen awakes in her dream, to find her bed is in front of the Elm street house. Children play outside, singing the infamous "Freddy" rhyme as they jump rope. A little girl on a red tricycle waits on the porch of the house as Kristen approaches cautiously. Kristen speaks to the little girl. We hear Freddy's blades scrape and the little girl turns and rides inside. Kristen follows her, pleading with her not to go in to the house.
"This is where he takes us!" the little girl announces as a boiler bursts into life. "Freddy's Home!!" Kristen grabs the girl and rushes towards the door, becoming trapped as the floor melts. Freddy chases her as she runs round the corner into hanging bodies. "Put me down, you're hurting me!" the little girl asks. Kristen looks down to see that she is clutching a dead and rotting body. She screams and "wakes" in her bed.
Kristen goes to the bathroom, unsettled by her nightmare. She goes to turn on the tap but it turns into a hand, grapping her and holding her in place, before she sees the image of Freddy Krueger appear in the mirror. The second tap also turns into a hand, with tiny blades at the end, like Freddy's claw. Freddy slices across Kristen's wrist, her screams finally bringing her mum. As Kristen's mum bursts into the bathroom Kristen wakes properly to find herself clutching a razorblade, blood oozing from her wrist and passes out.
The next scene takes us to Weston Hills psychiatric hospital. Max, the orderly and Dr. Gordon discuss a rash of teen suicides which have swept the area. They meet Taryn, a girl not sleeping, and Jennifer, a girl who has been self-harming, putting cigarettes out on her arms. He looks in on another boy in solitary for his violent outbursts. Dr Simms approaches and they talk about a new member of staff who has just left grad school, but has been making lots of progress with "pattern nightmares." Dr. Gordon is not keen on someone using "his kids" to further their own career.
At that moment an emergency message asks for both doctors to go to the examination rooms. Screaming can be heard as Elaine Parker discusses with a nurse her daughters attention seeking behaviour. As the doctors enter the room we see Kristen fighting and screaming hysterically as doctors try to sedate her. She grabs a scalpel begins to recite the rhyme: "1, 2 Freddy's coming for you, 3, 4 Better lock you door, 5, 6, Grab your crucifix, 7, 8 Better stay up late, 9, 10.... Never go to sleep again." She can't bring herself to speak the last line. Someone completes the last line, "Never sleep again" and everyone turns to see Nancy standing in the doorway. Nancy walks in and calmly takes the scalpel from Kristen before pulling her into a hug.
Nancy asks Dr. Gordon about the kids who all suffer from sleep disorders, including insomnia, narcolepsy and bed-wetting but all have nightmares in common. He believes they share a "group delusion" of a boogey man, which scares them so much they will do anything not to sleep. He elaborates with the story of a young boy who used razor blades to cut off his own eyelids to stop him sleeping. He praises her dealing with Kristen, and she reveals that she has had some experience with pattern nightmares. As she leaves, she drops her handbag and we see that Nancy is taking medication. He recommends she speak to Max and watches her leave. As he turns Dr. Gordon sees a nun dressed all in white who seems to then disappear.
Max shows Nancy to an office she can use and introduces her to some of the patients. First is Phillip, nicknamed the Walker because he sleep walks and who makes puppets. He shares a room with Kincade, the boy who was in solitary. Max jokes that Nancy should memorize his face as Kincade spends so much time in solitary she won't see much of him. Another patient Joey leaves his room to help a young nurse pick up towels which has fallen from her trolley.
Kristens mother, Elaine, and Nancy meet at their house to discuss her nightmares. Elaine is very dismissive, believing Kristen is just acting out and looking for attention. She tells Nancy she has packed a suitcase of Kristens belongings and directs Nancy to her room to get them. Nancy sees the model of her old house which Kristen had been working on.
Dr. Gordon looks up Hypnocil, the medication he had seen in Nancy's bag, to find that the drug is used to treat night terrors. We return to Kristen who is in bed drawing the Elm Street house. As she begins to doze the door to her room creaks open and a red tricycle wheels in before melting on the floor. She edges out of the room and finds herself back in the house. A stale barbequed pig with an apple in its mouth is on the table and flies buzz around before it leaps out at her.
Kristen explores, as a lump appears under the carpet and gashes in the walls. A huge snake with Freddy's face bursts out of the floor and begins to eat it's way up Kristen's body. She screams for Nancy and we see Nancy startled from her sleep. She looks at Kristen's model which she has taken home with her and hears Kristen scream again. Nancy passes out and falls through the chair to find herself in Kristen's dream. Nancy grabs a shard of broken mirror and stabs it into the eye of the snake, causing it to drop Kristen.
"YOU!" Freddy hisses. Unable to believe it Nancy grabs Kristen and begs her to run. They hide behind a door and Nancy tells Kristen to get them back out. They disappear as Freddy crashes through the door and Nancy awakes, back in her chair, with a cut on her hand from the mirror.
The next morning Nancy brings the model to Kristen, telling her it is where she used to live. She asks if she has ever pulled anyone into her dream the way she did. Kristen confides that when she was a child she would pull her Dad into her dreams if they were scary, allowing him to believe that they were his dreams instead. After her parents divorced it stopped and after a while Kristen thought she had simply imagined the whole thing. Kristen asks about the man in her dreams and Nancy assures her "he is real."
At group, Dr. Gordon tells the kids that it is "straight talk only" and then he and Dr. Simms introduce Nancy to the rest of the patients. Will Stanton is the first to introduce himself. He tells Nancy he had an accident, gesturing to the wheel chair he is sitting in. Taryn reveals though that he was injured in a suicide jump, not an accident. Kincade jumps to Wills defence and reveals that Taryn was a junkie, injecting into her arms. Jennifer Caulfield shares that she wants to be an actress on TV when she leaves the hospital. Jennifer goes on to introduce Joey who doesn't speak.
Taryn White is the next to introduce herself. She admits she is going through "some very strange shit" with her dreams and that the hospital is a better alternative to Juvie hall. Phillip interrupts, to say that the doctors all believe their dreams are group psychosis, despite the fact they all dreamt about Freddy before they had met and as a result just seem to go around in circles. Dr. Simms tells him they will not make any progress until the teens can accept the dreams as "By products of guilt; psychological scars stemming from moral conflicts and overt sexuality."
Taryn, Will and Joey play dungeons and dragons until Max comes to tell them that it is lights out. After Max and Taryn leave it is revealed that the boys take shifts to sleep. Nancy and Neil Gordon are getting coffee. He asks about Nancy's parents. She says her mum "Died in her sleep" and that she and her father don't have a good relationship. She tells Neil that the teens are in real physical danger from their dreams and he asks her about the Hypnocil she has been taking. He seems shocked that Nancy wants him to prescribe the drug to the kids. She confides she used to be like them, and tells Neil that their survival depends on it but he refuses.
One of Phillips puppets comes to life, morphing into a mini Krueger. Making it's way to Phillip's bed it turns into Freddy. Freddy cuts the veins in Phillip's arms and legs, creating puppet strings. Kincade sees Phillip being manipulated out of the room but thinking he is sleepwalking doesn't wake him. Freddy makes Phillip walk out of the ward and up the hospital tower. Joey sees Phillip standing at the edge of the ledge, waking Will and carrying him to the window. Joey tries to get help, banging a tray as he runs along the corridor to wake people. Will shouts from the window trying to wake Phillip. The group gathers to see Phillip fall to his death as Freddy cuts his strings.
In group the next morning the kids are all upset. Kincade is annoyed, blaming Phillips death on his weakness. Dr Gordon tries to tell them that it was suicide, which the others do not believe. Taryn says it was murder. Dr Simms tells the teens that to prevent a reoccurrence all rooms will be locked at night and they will be sedated. This freaks Kincade out, and as he gets irate Dr Simms beeps for security and he is sent to isolation once more. He is dragged away and despite Nancy's protests Simms says she is going to begin sedation that night. Neil decides to prescribe Hypnocil, despite Simms reservations.
Kincade is locked in the quiet room struggling to sleep. Jennifer is watching TV as research in the common room. Max tries to make her go back to her room but seeing she is upset allows her to stay so she doesn't sleep. Taryn has been showering and is accosted by an orderly who offers her, the keys to the dispensary. She says that she doesn't do that anymore and goes to her room. Jennifer finds a cigarette, lights it and then burns her hand to keep herself awake. She flicks through the channels, stopping on The Dick Cavett Show, which has Zsa Zsa Gabor as the guest. After a few minutes, Cavett suddenly turns into Freddy and attacks Gabor, after which the signal cuts out. Screams and the rhyme can be heard as Jennifer goes over to the TV. Arms burst out of the side of the television and grab Jennifer, before Freddy's head emerges from the top. Freddy shouts "Welcome to Prime-Time, bitch!" before fatally ramming Jennifer's head through the screen.
Neil watches at her funeral from a distance. The nun he saw earlier approaches him and asks him about his faith. He tells her that he saw her before and asks if Sister Mary-Helena does volunteer work at the hospital. She says she does from time to time, "When needed," and tells him that the only way to save the children is to put the unquiet spirit to rest. Nancy approaches and when he turns around the nun has disappeared.
Neil and Nancy share a meal and he sees Nancy's Malaysian dream doll which s supposed to bring good dreams. He is worried about the kids and doesn't know what to do. He can't make sense of it. Nancy wonders if he is ready to hear the truth, telling him to put everything else aside and just trust her.
In group, unofficially, Neil allows Nancy to tell the kids about Freddy. Although skeptical at first when she describes his dirty brown hat, his burnt face and the razors on his right hand they believe her. She tells them that the man is Freddy Krueger, a child murderer before he died and after something much worse. She shares the fact that six years ago he had killed her friends and almost killed her as revenge for his death. Their parents had burnt him alive after a mistake with a search warrant leading to his arrest caused all charges to be dropped and Krueger to go free.
Although unable to believe it at first the kids do believe it. Nancy reveals Kristens gift and tells the others that she is the key but that they all have their own inner strengths they can harness in the dream world. Neil tells them they are going to try a little group hypnosis. He gets them to relax and follow a pendulum as Nancy tells Kristen to take them to the dream world.
At first, little seems to have changed; they are in the same room and decide to take a break before trying again. Joey wanders out of the room, spotting the young nurse he helped previously. She tells him that she wanted to talk to him alone as she really likes him. She claims that she makes up excuses to come into the ward as he is soooo cute.
Dr Gordon sets off a perpetual motion device and the ball bearings break away and float around the room, revealing that they are actually dreaming, despite initial appearances. Neil struggles to believe till Will stands up. In his dreams he can walk, and is "The Wizard Master" which he demonstrates by turning a ball bearing into a butterfly. Kristen is able to back flip and somersault in her dreams, Kincade is super strong, Taryn is "beautiful and bad", but in the fill she looks the ugliest punk girl you could ever imagine!
Joey is in the room with the nurse. She asks him to unzip her uniform, revealing she is topless underneath. Asking if he likes her body Joey nods enthusiastically. She pushes him back on the bed and kisses him, before biting his tongue and pulling it from his mouth. Tongues are used to bind Joeys wrists and ankles and the nurse is revealed to be Krueger. "Feeling tongue-tied?" he asks. The mattress disappears to reveal a hell pit.
At this moment the others realize that Freddy is close and he has Joey. The room morphs into a boiler room, despite Kincades attempts to stop it. The screams alert Dr. Simms who is not happy. Joey is on the floor, seemingly in a coma. This is blamed on the Hypnocil Dr. Gordon has prescribed and both he and Nancy are suspended. As he clears out his stuff Neil looks at a photograph and is then distracted by Sister Mary-Helena in the tower. The door is locked but Neil breaks in and climbs the tower.
The nun is at the top of the tower. She reveals that the room was once used to house the most dangerous, criminally insane patients at the hospital. The wing was closed in the forties after a young girl was locked in the wing over the holidays. The inmates kept her hidden for days, raping her hundreds of times. When she was found she was barely alive and was most unfortunately impregnated. The girl was Amanda Krueger, Freddy's mum. She tells Neil that the only way to stop Freddy is to find his remains and then bury them in hallowed ground.
Nancy visits with Joey. She demands that Freddy releases him. The words "Come and Get him Bitch" appear carved on his chest. Nancy wants to go into the dream realm and fight Freddy but Neil tells her they have another option. She agrees to try and she tells him that only one man will know the whereabouts of the remains. Kristen fights against staff as it is revealed that Nancy has been suspended. She is taken to the quiet room and sedated for her outburst, screaming that Dr Simms is killing them!
The man Nancy referred to is revealed to be her Dad. They meet him in a bar and he is clearly drunk and although initially pleased to see her when Nancy reveals the reason for the visit is less happy. He insists Nancy just needs to let it go because Krueger is dead. Despite Nancy's pleas he refuses to reveal where the bones are and dismisses her. Nancy is very upset.
Taryn pages Dr Gordon, informing him that Kristen has been sedated and locked in the quiet room. He urges Nancy to go to the hospital and to convince Dr Simms what is happening is real. He tells her he will speak to her father and make him tell the location of Freddy's remains. He goes back into the bar, introduces himself and then throws Lt. Donald Thompson against the wall. Neil says that he cares if Nancy lives or dies even if her father doesn't and so they are going on a scavenger hunt.
Neil drives them to a church, takes the keys and leaving Donald outside goes to get holy water and a crucifix. He is stopped by a priest and leaves his driving license in return for the things he needs, promising to return them. Nancy arrives at the hospital and Max prevents her from seeing Kristen but reluctantly agrees to let her see the others. She finds them in the TV room and takes them for a last group session. Neil and Nancy's dad pull up at The Penny Bros Auto Salvage yard, the hiding place of Freddy's remains. Going inside, Neil is directed to the heart of the place.
Nancy tells Kincade, Will and Taryn that Joey and Kristen need them. She assures them nobody has to go in, warning them if they die in the dream world then they die for real. They all want in so urging them to stick together they imagine themselves in the quiet room with Kristen. When Nancy counts back from five they are there in the room with Kristen who is delighted to see them. Kristen says that Joey needs them. Nancy asks where he is and at that moment the padded walls are ripped to shreds by Freddy's claws. Terrified the group huddles in the centre of the room, padding showering them.
As the padding clears, Kristen is back in her bedroom, working on the model house as she was the night of her "suicide attempt." She is surprised as her mum bursts in, and the night repeats itself. She gives her mum a huge hug, telling her she has had a terrible dream. She asks her mum to stay with her but her mum has a guest. This time it turns out to be Freddy, who rips Elaine's head off and the decapitated head admonishes Kristen for her attention seeking behaviour. Freddy tries to stab Kristen but she uses her gymnastic skills to evade him. She jumps out the window but instead of landing outside finds herself in the Elm Street house, rolling down the stairs.
Getting to her feet Kristen calls for Nancy. She is heard by Taryn who tries to find her, instead finding herself in an alley. A wall appears behind her, with Taryn and Freddy in a heart sprayed on it, trapping her. Taryn is shocked by Freddy who say's "Welcome Home....Look familiar?" Taryn uses flick knives to fight Freddy, stabbing him in the stomach. Freddy asks why they are fighting when they are old friends and holds his hands up to reveal syringes of blue liquid instead of blades. Taryn backs away, as the injection marks on her arm begin to suck. Freddy plunges both sets of syringes into Taryn, throwing her aside, dead. "What a rush!" he declares.
Will finds himself in a long passage way. He calls out for the others, hearing Freddy laugh. He turns to find a wheelchair. Freddy invites him to sit, reminding him he will be back in it when he wakes up. The chair chases Will causing him to fall. He calls on his "Wizard Master" powers. Rising to his feet, Will shouts, "In the name of Lowrek, Prince of Elves, demon begone" and blasts Freddy with green light. He runs towards Freddy who grabs him. Saying he doesn't believe in fairy tales he plunges his blades into Wills chest, killing him too.
Kristen continues her search for the others, finally finding Nancy. The wall to the room begins to break and Kincade is revealed, using his super strength to reunite them. They embrace and Kincade shouts for Freddy. A door to the boiler room appears behind them. Nancy leads the way down a spiral staircase to search for Freddy.
Meanwhile, Neil and Donald finally reach the centre of the salvage yard. Donald directs Neil to a red caddy. After a struggle he opens the boot to reveal the remains of Fred Krueger rapped in a sack. Donald tries to escape but Neil has the keys and tells him he is going to attend a funeral, "one that is long overdue." He throws him a spade.
Nancy and the others reach the bottom of the staircase to find Joey suspended over a hell pit. Freddy appears and when Nancy tells him to let Joey go, he undoes the tongue bindings. Nancy reaches Joey just in time to stop him falling. Kristen attacks Freddy as Kincade pulls Nancy and Joey to safety. He strikes Freddy with a length of pipe and when Freddy grabs him by the throat Nancy drives a thin lead pipe through him. His shock quickly turns to a sinister smile and still holding Kincade by the throat he pulls it out, discarding it.
Nancy can not believe how strong Freddy has become. He informs her that the souls of the children make him strong, pulling aside his jumper to reveal the faces of screaming children on his torso. Then he disappears.....causing Kincade to fall to the floor.
In the real world at the salvage yard, Neil and Nancy's father have dug a grave. They stop when Neil hears noises and after Donald assures him that they are alone all the cars come to life, lights flashing, boots and doors flapping and horns blasting. Donald screams "Bury the fucking thing!" but as Neil approaches the remains the skeleton reanimates, taking swipes at him with his bladed hand. Donald stands, shocked. "It's really you....I killed you once before you son of a bitch!" Donald attacks, but ends up impaled on a spike of metal. Neil attempts to fight Freddy but is hit with the spade and knocked into the grave. Freddy begins to shovel dirt onto him, as he lies unconscious.
Laughing, the skeleton collapses and Freddy returns to the dream realm. Nancy, Kristen, Kincade and Joey are walking along a corridor, papered in red and decorated with mirrors. A large mirror appears, blocking their path and then Freddy appears. He apologizes for keeping them waiting and says "If only there was more of me to go around?!" his image then appears, laughing in all of the mirrors. Joey backs into a corner, clearly scared. The Freddy's grab the others, dragging them into the mirrors. Joey stands and screams "NO!!" All the mirrors smash, freeing the others. They believe it to be over.
Nancy's father appears, telling her he has crossed over but couldn't go without telling her that he was sorry for all the things he had done, and that he loves her. Nancy embraces her father then gasps as her father turns into Freddy and plunges his claws into her stomach. "Die!" he snarls as he pushes the blades in deeper. Neil finally awakens, semi buried in the grave.
Kristen screams and Freddy causes the door behind her to close, separating her from Kincade and Joey. "You're mine now, little piggy!" He tosses Nancy aside and knocks Kristen to the floor. Holding his arm back, he is about to stab her when Nancy grabs him, forcing his blades into himself instead.
Neil climbs out of the grave, kicks in the bones of Krueger and splashes them with holy water. As he does, rays of holy/spiritual light appear on Freddy's torso. Nancy is once more tossed aside, landing by Kristen. Neil continues to splash holy water, "Ashes to ashes, dust to dust, I lay this spirit to rest." He places the crucifix on his head, causing Freddy to spin and explode in a ball of golden light, a cross of light on his forehead.
Kristen sobs as Kincade breaks down the door. Kristen says she won't let Nancy die and will instead dream her into a beautiful dream. Kristen holds Nancy's dead body.
Kincade, Joey, Kristen and Neil all attend Nancy's funeral, Neil with a sling on his arm. He turns to see the nun, Sister Mary-Helena walking through the graveyard. He follows her but before he can speak to her she disappears. he looks down at the grave he is standing on to see it is Amanda Kruegers and also bears the name Sister Mary-Helena, revealing the nun to be the ghost of Freddy Krueger's mother.
Neil sleeps as the shot reveals that he is now in possession of the Malaysian dream doll and Kristens model of 1428 Elm Street. As he sleeps, the bedroom light in the model comes on.... hinting Freddy may be back after all!