Malka Leifer, the former principal of a Jewish girls' school in Melbourne, fled to Israel in 2008 after accusations were raised against her.
Ms Leifer says panic attacks stop her coming to court. Extradition hearings have been delayed for two years so far.
Based on a psychiatric report, a judge has decided Ms Leifer will not face court until she completed treatment.
Ms Leifer allegedly raped and indecently assaulted girls at the ultra-Orthodox Adass Israel School in Melbourne, Australia.
The court in Jerusalem has also lifted her house arrest, meaning she will be able to move freely for the first time since Israeli police arrested her in 2014. Prosecutors are expected to appeal this decision.
Ms Leifer will begin an initial six months of treatment before a committee assesses whether she is fit to face future extradition proceedings.
"We are committed to seeing this woman extradited to Australia to face these very serious child sex abuse charges," Australia's ambassador to Israel, Dave Sharma, told the Australian Broadcasting Corp.
"We are determined to be patient and persevere to this end with the view to seeing her extradited."
An Israeli woman facing 74 child sex charges in Australia is mentally unfit to face extradition, a court says.