She studied fine arts at the Florida State University and received her bachelor's degree in drama from the University of Michigan, then toured Europe as part of a pantomime acting troupe. She then headed to New York City, where she worked as a waitress and did commercials. Her breakthrough movie was ...And Justice for All (1979) with Al Pacino. After starring in a few blockbuster hits in the 1970s and early 1980s, Lahti has primarily chosen to be in movies she wants to act in, rather than take blockbuster roles, and she is adamant about spending time with her three children. She has also chosen to focus on television, beginning with her role in the 1979 made-for-TV adaptation of The Executioner's Song. She appeared on Broadway in Wendy Wasserstein's seriocomic play, The Heidi Chronicles.

Lahti received an Academy Award nomination for Best Supporting Actress for Swing Shift in 1984, and won an Academy Award for Best Short Film, Live Action for Lieberman in Love (1995), which she starred in and directed.

She has won one Emmy and two Golden Globes for her role in Chicago Hope. When she won her Golden Globe in 1998, she was in the bathroom, which was highly-publicized in the press. After that event, she made it a point to be good-humored about it, usually poking fun at herself at other awards shows. She was later dropped from the show unceremoniously.

Lahti is married to TV director, Thomas Schlamme, a native of Texas. She mainly has acted in independent films or TV series in the past decade, and she is active in political causes.

Since May, 2005, she has been a contributing blogger at The Huffington Post.