McMurtry states in his memoir that he spent his first five or six years in his grandfather's house on a ranch without books, but his extended family would sit on the front porch every night and tell stories. In 1942, when his cousin Robert Hilburn on his way to enlist for World War II stopped by the ranch house and left a box containing 19 books, he began to read. The books were standard boys' adventure tales of the 1930s, and he read them to tatters. The first book he read was Sergeant Silk: The Prairie Scout.

McMurtry was born in Archer City, Texas, 25 miles from Wichita Falls, Texas, the son of Hazel Ruth (née McIver) and william Jefferson McMurtry, who was a rancher. He grew up on a ranch outside Archer City, which is the model for the town of Thalia that appears in much of his fiction. He earned degrees from the University of North Texas (B.A. 1958) and Rice University (M.A. 1960).

During the 1960–1961 academic year, McMurtry was a Wallace Stegner Fellow at the Stanford University Creative Writing Center, where he studied the craft of fiction under Frank O'Connor and Malcolm Cowley alongside a number of other Writers, including Ken Kesey, Peter S. Beagle, and Gurney Norman; Stegner himself was on sabbatical in Europe during McMurtry's fellowship year.

McMurtry has won the Jesse H. Jones Award from the Texas Institute of Letters on three occasions: in 1962, for Horseman, Pass By; in 1967, for The Last Picture Show, which he shared with Tom Pendleton's The Iron Orchard; and in 1986, for Lonesome Dove. He has also won the Amon G. Carter award for periodical prose in 1966, for Texas: Good Times Gone or Here Again?. In 1986, McMurtry received the Peggy V. Helmerich Distinguished Author Award. The Helmerich Award is presented annually by the Tulsa Library Trust.

McMurtry and Kesey remained friends after McMurtry left California and returned to Texas to take a year-long composition instructorship at Texas Christian University. In 1963, he returned to Rice University, where he served as a lecturer in English until 1969; his initial students were entertained with stories of Hollywood and the filming of Hud for which he was consulting. In 1964, Kesey's famous cross-country trip with his Merry Pranksters in the day-glo-painted school bus Furthur, chronicled in Tom Wolfe's The Electric Kool-Aid Acid Test, included a stop at McMurtry's home in Houston. That same year, McMurtry was awarded a Guggenheim Fellowship.

While at Stanford, McMurtry became a rare-book scout, and during his years in Houston, managed a book store there called the Bookman. In 1969, he moved to the Washington, DC, area, and in 1970 with two partners started a bookshop in Georgetown which he named Booked Up. In 1988, he opened another Booked Up in Archer City, which is one of the largest used bookstores in the United States, carrying between 400,000 and 450,000 titles. Citing economic pressures from internet bookselling, McMurtry came close to shutting down the Archer City store in 2005, but chose to keep it open after an outpouring of public support.

In 2006, he was cowinner (with Diana Ossana) of both the Best Screenplay Golden Globe and the Academy Award for Best Adapted Screenplay for Brokeback Mountain. He accepted his Oscar wearing jeans and Cowboy boots along with his dinner jacket, and used his speech to promote books by reminding his audience that "Brokeback Mountain" was a short story by E. Annie Proulx before it was a movie. In his Golden Globe acceptance speech, he paid tribute to his Swiss-made Hermes 3000 typewriter.

McMurtry described his method for writing novels in Books: A Memoir. He says that from his first novel on he would get up early and dash off five pages of narrative. At the time of publication of the memoir in 2008, he stated that it was still his method, although by then he was up to dashing off 10 pages a day. He also writes every day, ignoring holidays and weekends.

His former wife, Jo Scott McMurtry, an English professor, is also the author of five books. Their son, James McMurtry, and grandson Curtis McMurtry are singer/songwriters and guitarists. On May 5, 2011, The Dallas Morning News reported that McMurtry married Norma Faye Kesey on April 29 in a civil ceremony in Archer City. She is the widow of Writer Ken Kesey.

In early 2012, McMurtry decided to downsize and sell off the greater portion of his inventory. He made the decision as he felt the collection was a liability for his heirs. The auction was conducted on August 10 and 11, 2012, and was overseen by Addison and Sarova Auctioneers of Macon, Georgia. This epic book auction sold books by the shelf, and was billed as "The Last Booksale" in keeping with the title of McMurtry's The Last Picture Show. Dealers, Collectors, and gawkers came out en masse from all over the country to witness this historic auction. As stated by Mr. McMurtry on the weekend of the sale, "I've never seen that many people lined up in Archer City, and I'm sure I never will again."

McMurtry is perhaps best known for the film adaptations of his work, especially Hud (from the novel Horseman, Pass By), starring Paul Newman and Patricia Neal; the Peter Bogdanovich–directed The Last Picture Show; James L. Brooks's Terms of Endearment, which won five Academy Awards, including Best Picture (1984); and Lonesome Dove, which became a popular television miniseries starring Tommy Lee Jones and Robert Duvall.