Schrader earned his B.A. from Calvin College, with a minor in theology. He then earned an M.A. in film studies at the UCLA Film School upon the recommendation of Pauline Kael. With Kael as his mentor, he became a film critic, writing for the Los Angeles Free Press and later for Cinema magazine. His book Transcendental Style in Film: Ozu, Bresson, Dreyer, which examines the similarities between Robert Bresson, Yasujirō Ozu, and Carl Theodor Dreyer, was published in 1972. The endings of his films American Gigolo and Light Sleeper bear obvious resemblance to that of Bresson's 1959 film Pickpocket. His essay Notes on Film Noir from the same year has become a much-cited source in literature on film.

In 1974, Schrader and his brother Leonard co-wrote The Yakuza, a film set in the Japanese crime world. The script became the subject of a bidding war, eventually selling for $325,000. The film was directed by Sydney Pollack and starred Robert Mitchum. Robert Towne, best known for Chinatown, also received a credit for his rewrite.

Although The Yakuza failed commercially, it brought Schrader to the attention of the new generation of Hollywood Directors. In 1975 he wrote the script for Obsession for Brian De Palma. Schrader wrote an early draft of Steven Spielberg's Close Encounters of the Third Kind (1977), but Spielberg disliked the script, calling it "terribly guilt-ridden," and opted for something lighter. He also wrote an early draft of Rolling Thunder (1977), which the film's producers had reworked without his participation. He disapproved of the final film.

Schrader's script about an obsessed New York City taxi driver became Martin Scorsese's film Taxi Driver, which was nominated for the Academy Award for Best Picture and won the Palme d'Or at the Cannes Film Festival. Besides Taxi Driver (1976) Scorsese also drew on scripts by Schrader for the boxing tale Raging Bull (1980), co-written with Mardik Martin, The Last Temptation of Christ (1988), and Bringing Out the Dead (1999).

Thanks partly to critical acclaim for Taxi Driver, Schrader was able to direct his first feature, Blue Collar (1978), co-written with his brother Leonard. Blue Collar features Richard Pryor, Harvey Keitel, and Yaphet Kotto as car factory workers attempting to escape their socio-economic rut through theft and blackmail. He has described the film as difficult to make, because of the artistic and personal tensions between him and the cast. During principal photography he suffered an on-set mental collapse which led him to seriously reconsider his career. John Milius acted as executive Producer on the following year's Hardcore, again written by Schrader, a film with many autobiographical parallels in his depiction of the Calvinist milieu of Grand Rapids, and in the character of George C. Scott, which was based on Schrader's father.

Among Paul Schrader's films in the 1980s were American Gigolo starring Richard Gere (1980), his Cat People (1982) a remake of the 1942 film Cat People, and Mishima: A Life in Four Chapters (1985). Inspired by Japanese Writer Yukio Mishima, the film interweaves episodes from Mishima's life with dramatizations of segments from his books. Mishima was nominated for the top prize (the Palme d'Or) at the Cannes Film Festival. Francis Ford Coppola and George Lucas served as executive producers.

Schrader also directed Patty Hearst (1988), about the kidnapping and transformation of the Hearst Corporation heiress. In 1987, he was a member of the jury at the 37th Berlin International Film Festival.

His 1990s work included the travelers-in-Venice tale The Comfort of Strangers (1990), adapted by Harold Pinter from the Ian McEwan novel, and Light Sleeper (1992), a sympathetic study of a drug dealer vying for a normal life. In 2005 Schrader described Light Sleeper as his "most personal" film. In 1997 he made Touch (1997), based on an Elmore Leonard novel about a young man seemingly able to cure the sick by the laying on of hands.

Schrader has written two stage plays, Berlinale and Cleopatra Club. The latter saw its premiere at the Powerhouse Theater in Poughkeepsie, New York, in 1995 and its foreign language debut in Vienna in 2011.

In 1998, Schrader won critical acclaim for the drama Affliction. The film tells the story of a troubled small town policeman (Nick Nolte) who becomes obsessed with solving the mystery behind a fatal hunting accident. Schrader's script was based on the novel by Russell Banks. The film was nominated for multiple awards including two Academy Awards for acting (for Nolte and James Coburn). The same year, Schrader received the Austin Film Festival's Distinguished Screenwriter Award.

In 1999, Schrader received the Laurel Award for Screenwriting Achievement from the Writers Guild of America.

In 2002, he directed the acclaimed biopic Auto Focus, based on the life and murder of Hogan's Heroes actor Bob Crane.

In 2003, Schrader made entertainment headlines after being fired from The Exorcist: Dominion, a prequel film to the horror classic The Exorcist from 1973. The film's production companies Morgan Creek Productions and Warner Bros. Pictures greatly disliked the film Schrader had made. Director Renny Harlin was hired to then re-shoot nearly the entire film, which was released as Exorcist: The Beginning on August 20, 2004 to disastrously negative reviews and embarrassing box office receipts. Warner Bros. and Morgan Creek put over $80 million into the endeavor and Harlin's film only made back $41 million domestically. Schrader's version of the film eventually premiered at the Brussels International Festival of Fantastic Film on March 18, 2005 as Exorcist: The Original Prequel. Due to extreme interest in Schrader's version from critics and cinephiles alike, Warner Bros. agreed to give the film a limited theatrical release later that year under the title Dominion: Prequel to the Exorcist. The film was only shown on 110 screens around the United States and made just $251 thousand. The critics liked Schrader's version much better than Harlin's. However, Schrader's film ultimately met with a generally negative reaction.

Schrader headed the International Jury of the 2007 Berlin International Film Festival, and in 2011 became a jury member for the ongoing Filmaka short film contest.

On July 2, 2009, Schrader was awarded the inaugural Lifetime Achievement in Screenwriting award at the ScreenLit Festival in Nottingham, England. Several of his films were shown at the festival, including Mishima: A Life in Four Chapters, which followed the presentation of the award by Director Shane Meadows.

After five years of trying and failing to find funding to make feature films, Schrader returned with The Canyons (2013) an erotic dramatic thriller written by Bret Easton Ellis and starring Lindsay Lohan and adult-film star James Deen. The film gained notability as it was one of the first films to use the website Kickstarter to crowd-source its funding. Schrader also used the website Let It Cast to have unknown actors submit their audition tapes over the internet. American Apparel stepped in to provide some wardrobe for the film. The film gained media coverage due to Lohan's notorious on-set behavior, as well as the film's unusual production route. The film was ultimately made for just $250 thousand and had a limited theatrical release from IFC Films on August 2, 2013. The film was poorly received by general critics and audiences. The film only made $56 thousand in theaters but found later success when released on various Video on Demand platforms.

As of April, 2014, Schrader was in post-production on The Dying of the Light, an espionage thriller starring Nicolas Cage as a government agent suffering from a deadly disease, Anton Yelchin and Irène Jacob. the film was savaged by many film critics and was a devastating box-office bomb.