Freddy Krueger is trapped in Hell, and enraged as the parents of Springwood have emerged from their psychosis and figured how to keep the children from remembering him, rendering him powerless and unable to escape. Determined to make them remember and fear him, Freddy locates Jason Voorhees in Hell and disguises himself as Jason's mother, who is the only person Jason will listen too, convincing him to rise again and go to Springwood to slaughter the teens; though Jason will kill, Freddy will be blamed, and thus be able to escape. Jason arrives on Elm Street, sneaking into the house where Nancy Thompson and Jesse Walsh used to live, now owned by Lori Campbell and her widowed father. While Lori, her friends Kia, Gibb, Blake and Trey, are in the house, Trey is brutally murdered by Jason using his machete and bent in half. The group is taken in for questioning. After overhearing several police officers accidentally discussing Freddy, Lori falls asleep and has a dream about Freddy, allowing him to gain some of his powers back. Freddy then tries to attack Blake. However, he is unable to harm him, so he decides to rest for now and "let Jason have some fun." Blake then awakens to find his father beheaded, sitting next to him, and is, a moment later, killed by Jason. In order to avert suspicion from Freddy, the police claim that Blake killed Trey, his father and then sacrificed himself.
Lori has recurring dreams about Freddy and tells Kia and Gibb about it. She is reunited with her boyfriend, Will Rollins and his friend Mark, who were institutionalized in Westin Hills Asylum and escaped after hearing of the murders on Elm Street. At a rave party, Gibb falls asleep and has a dream where she is attacked by Freddy after he took the form of the deceased Trey to lure her into his trap. Another raver attempts to rape her, but Jason appears and kills the two, angering Freddy, who realizes that Jason will not stop killing and that the public is becoming more afraid of Jason than him. Jason goes on a rampage around the rave, killing Shack and several others. Afterward, Will, Lori, Kia, and two fellow students Freeburg and Linderman escape and meet up with Stubbs. The group formulate a plan to defeat Freddy and Jason: they will take Jason back to Camp Crystal Lake, and Lori will pull Freddy into the real world to fight Jason; in the real world, Freddy will be vulnerable, and Jason, at home in Crystal Lake, will have the "home field advantage" and remain in his territory, and thus no longer terrorize Springwood. Freddy kills Mark while leaving a bloody "message" on his back that says "FREDDY'S BACK", and then possesses Freeburg's body to stop the group from taking Hypnocil, a drug that will prevent them from sleeping and dreaming. Jason electrocutes Stubbs and is then confronted by Freddy in Freeburg's body, who injects Jason with two vials of tranquilizer. Jason bisects Freeburg before passing out.
Once inside Freddy's dream world, Jason realizes he was tricked and engages Freddy. At first Freddy thinks that Jason is afraid of nothing, which combined with his real-world invincibility makes him impossible to kill even in the dream-world. But then Freddy accidentally discovers Jason's fear of water (even though Jason has used water to his advantage in many previous films), then exploits it to turn Jason back into a child, then brings him to a nightmare of his childhood, and starts to drown him.
But before Freddy can kill Jason, Lori enters the Dream World and interrupts the fight, causing Jason to wake up and attack the group, who are now at Crystal Lake. Freddy, enraged, attempts to kill Lori, after revealing that he was the one, who killed her mother, but she awakens and drags him into a burning cabin in reality. Jason turns his attention to Freddy, who is somewhat paralyzed by his fear of fire and whom Jason beats up and throws through the burning cabin's roof. Lori, Will, Kia and Linderman try to escape, but Linderman is wounded and dies soon afterwards. Kia tries to save Lori and Will from Freddy, but is killed suddenly by Jason. Freddy and Jason continue their battle and Lori decides to stay until Freddy is dead. While Freddy seems to be no match for Jason's physical power, he still heavily wounds Jason because of his superior speed and agility. During their fight, Lori and Will burn the gas tanks at the docks to blow both Freddy and Jason up. Until then Jason already lost four fingers and his eyes. When the fire starts to spread Jason rips off Freddy's arm with the claws and Freddy stabs Jason's heart with the machete. The resulting explosion sends both of them into the lake. Freddy comes back and attempts to kill Lori with Jason's machete. Jason ultimately defeats Freddy despite appearing to die in the process, stabbing him with Freddy's own claws before falling into Crystal Lake, though if he did this to continue battling Freddy or for some reason save Lori for saving him earlier is unknown. Lori picks up Jason's machete, while Freddy kneels on the dock helplessly. She shouts at Freddy "Welcome to my world bitch!" then uses the machete to behead Freddy (much like Pamela Voorhees' death in the first Friday ) and throws the machete to Jason as he sinks. Lori and Will depart, but the next morning Jason rises from the water, carrying his machete and Freddy's severed head, which smirks and winks at the audience before laughing maniacally, leaving the winner ambiguous.