Costello was born in Pittsburgh, Pennsylvania, the daughter of actors Maurice Costello and and Mae (nee Altschuk). She made her first film appearances, along with her sister Helene, as a child in her father's films. The two sisters appeared on Broadway together and their success resulted in contracts with Warner Brothers Studios. By the mid twenties, she had become a successful and highly regarded film personality in her own right, and as a young adult her career developed to the degree that in 1926 she was named a WAMPAS Baby Star, and had acquired the name "The Goddess of the Silver Screen." In 1926, she starred along with John Barrymore in The Sea Beast and after a two year affair, the couple married in 1928. Costello spoke with a lisp (something that her granddaughter, Drew Barrymore has seemed to inherit), and found it difficult to make the transition to talking pictures, but after two years of voice coaching she was comfortable speaking before a microphone. Her acting career became less of a priority for her following the birth of her children, however her marriage to Barrymore proved to be a difficult one due to his increasing alcoholism, and they were divorced in 1935.

Costello attempted to resume her career and achieved some successes, most notably in Little Lord Fauntleroy (1936), and The Magnificent Ambersons (1942), and she retired in 1943.

Shortly before her death, she agreed to be interviewed for the documentary series Hollywood discussing her film career. She died from emphysema in Fallbrook, California in 1979 and was interred in the Calvary Cemetery, East Los Angeles. Her interview scenes were broadcast posthumously in 1980.

Dolores Costello has a star on the Hollywood Walk of Fame for her contributions to Motion Pictures, at 1645 Vine Street.