The film opens with home video footage of Kristi Rey (Sprague Grayden) bringing her newborn son Hunter (William Juan Prieto & Jackson Xenia Prieto) home from the hospital. We then follow Hunter through the first several months of his life via a montage of various video clips. We meet Kristi's husband Dan Rey (Brian Boland), Ali (Molly Ephraim), his daughter from a previous marriage, Martine (Vivis Cortez), the family's housekeeper/nanny and Abby, the family's German Shepherd.
A year after Hunter is born, the family comes home to find their house seemingly broken into (though both doors were locked) and trashed, though the only thing missing is a necklace which Kristi's sister Katie (Katie Featherston) had given to her. Dan has a number of security cameras installed throughout the house - in the backyard, baby's room, kitchen, living room, entryway, and outside the front door.
The first night, suspicious activity begins, with the pool light flickering and eventually dying out in the middle of the night, and the pool cleaner being taken out of the pool. Soon pots begin to fall seemingly of their own accord in the kitchen. Hunter is repeatedly woken up in the middle of the night by loud banging sounds from inside the house and outside his window, and Abby is seen staring at something unseen in Hunter's room and barking or growling at it. After one evening where this happens, Martine attempts to cleanse the house of "evil spirits." Upon discovering the nanny performing these acts, Dan fires her. Katie and Kristi reveal that, as children, they felt they were tormented by a demon or unknown spirit, but they tried to keep the ordeal a secret and not talk about it. Ali begins investigating the mysterious happenings. She discovers that, if a human makes a deal with a demon for wealth or power, the payment for said deal is the life of the family's first-born male; coincidentally, Hunter is the first male to be born into Kristi and Katie's side of the family since their great-great-grandmother was alive.
Kristi confides in Katie everything that has been happening, and tries to bring up how, as children, they felt demons around them; Katie becomes really angry and demands that Kristi not pay the events any attention, for it would just make things worse. Soon after, while Kristi is in the kitchen, the cupboards are flung open and everything explodes out of them. The violence continues to escalate; the family dog, Abby, is attacked and pulled violently off camera and knocked unconscious. Dan and Ali take the dog to the vet, leaving Kristi alone with Hunter. She goes to check on the baby and notices a light flicker off. She turns the light back on, but then is dragged by an unseen force out of the room and halfway down the stairs before she is released. Kristi runs back upstairs into Hunter's room but she is dragged back downstairs, this time into the basement where she stays for over an hour. Finally, the basement door opens and Kristi emerges, dazed and presumably possessed.
The following day, Ali is at home with Kristi, who won't get out of bed. Ali goes upstairs after hearing several banging sounds to find Kristi sitting in the baby's room with a bite mark on her thigh, while Hunter is crying for unknown reasons. She hears a thump in her own room and goes to investigate, yet looks back to find Kristi has left Hunter's room. Ali goes back later to comfort a screaming Hunter while Kristi stands in his room at the window, staring out at everything; when Ali gets too close, however, she turns and commands that Ali not go near him. Ali calls Dan, crying, and begs him to come home. When he arrives, she shows him the footage from the night before of Kristi being dragged down the stairs. Dan immediately calls Martine, who prepares a cross that will force the demon out of Kristi. But she adds one last detail: the demon will have to be passed on afterwards to someone else, a blood relative, to keep it from returning. Dan tells Ali that he is going to pass the demon onto Katie so that Kristi and Hunter will be saved; she pleads with him not to, but he doesn't listen.
Dan approaches Kristi, who is sitting up in bed in a daze. He attempts to touch her with the cross, but she bites him, and all the lights in the house go out. Kristi and the baby disappear, and Ali says that they're in the basement. After fumbling around and knocking things over in the dark, Dan finds Hunter in a corner of the basement, seemingly alone. From behind, Kristi attempts to attack him, knocking the camera from his hands. Dan manages to put the cross on her chest to remove the demon from her body. The floor begins to shake and demonic yells are heard. The next scene shows Dan putting Kristi to bed and then burning a photo of a young Katie, to pass the demon on to her.
Three weeks later, Katie visits and explains how things have now begun happening at her house; Kristi, having no memory of Dan's actions, says that the paranormal events have stopped at her house, and that Katie should follow her own advice and not pay any attention to what is going on. After Katie leaves, we see her arrive at her and Micah's house, where he has just purchased the camera. This is where the events of Paranormal Activity take place, as the demon slowly begins to infiltrate Katie and Micah's life and eventually possess Katie and kill Micah.
The next scene cuts to the night after Micah was murdered. Dan is watching television in the living room and Kristi is in the baby's room, holding Hunter because he had woken up crying. Katie, possessed and bloodstained from the murder of Micah, is seen standing in the entry of the house behind Dan. She approaches him silently from behind and snaps his neck. Kristi hears the commotion downstairs, then spots Katie approaching her from the dark hallway. Katie violently throws Kristi against a wall, killing her and Hunter begins to cry. The final scene is Katie calmly leaving the room with Hunter, who begins to giggle as they disappear down the hallway.
The ending credits say that Ali was on a school trip and returned home to find her father and step-mother dead. Katie and Hunter's whereabouts remain unknown.