She attended St. Anthony Girls' High School, located in Chembur, and later attended Podar College. She is a trained Bharatanatyam dancer. She is also into sports and was the captain of the baseball team in school and earned a black belt in Karate and currently a dancesport expert and enthusiast.

Shetty currently lives in Mumbai with her parents and sister. Her younger sister Shamita Shetty is a budding Bollywood actress and they worked together in the film Fareb (2005).

Shetty started her career by modelling for Limca in 1991 at age 16, and made her film debut in 1993 at age 17 in Baazigar, portraying a woman murdered by her psychopathic boyfriend. Although she was a supporting actress alongside Shah Rukh Khan and Kajol, the film was a major success and earned her a nomination for the Filmfare Best Supporting Actress Award.

Her first leading role was in the film Aag in 1994, which was averagely received at the box office. She had a hit that same year with the film Main Khiladi Tu Anari opposite Akshay Kumar. This was followed by many films which were average to poor performers at the box office. Shetty starred another big film that year Aao Pyar Karen followed by Hathkadi in 1995 where she was working alongside actors such as Saif Ali Khan, Govinda and Madhoo but they failed at the box office. 1997 was one of her busiest years yet, she appeared in six different films, beginning with the small Telugu language film Veedeva Dani Babu. Her first major Bollywood film of that year was the action thriller Auzaar. Shilpa portrayed the character of Prathna Thakur alongside actors Salman Khan and Sanjay Kapoor. In 1998, she had one release, Pardesi Babu (co-starring Raveena Tandon and Govinda), for which she received critical acclaim and won best supporting actress

In 2000 Shetty received much acclaim for her role in Dhadkan which earned reasonable takings at the Indian box office. She received several nominations under the Best Actress category in different awards ceremonies, although she lost them to Karisma Kapoor. She would later go on to star with Kapoor in the film Rishtey (2002). Her performance as an eccentric fisherwoman was appreciated and she received a nomination under the Filmfare Best Supporting Actress Award category.

2004 was also a good year for Shetty with the release of Garv in which she portrayed a Muslim orphan and disillusioned table dancer starring opposite Salman Khan. Unlike the similar Chandni Bar, Garv was a cop drama that did not make the same social impact but which Shetty chose to do because she liked the subject. However, she received much acclaim for her performance in Phir Milenge which critics consider as her best performance so far, where she makes a sensitive portrayal of a successful city high-flyer who contracts HIV via unprotected sex and becomes a social outcast as a result. The film, based on 1993's Philadelphia, was perceived to have tackled a social taboo as yet unaddressed by Bollywood and earned Shetty a Filmfare Best Actress nomination, and also provided an impetus for her HIV-related charity work (see below). The actress was also a guest judge on the Indian Idol television show.

This marked a break from the previous trend of superficial song-and-dance items in favour of "meatier roles" exemplified by her film Dus (2005), an action thriller. Although it received average returns at the box office, Shetty stated that she had taken the role in order to reinvent herself by portraying the rather unconventional character of an anti-terrorist squad member. She also starred with her sister in the film Fareb in 2005. Shilpa had one release in 2006, the much delayed Shaadi Karke Phas Gaya Yaar. The film was a box office flop but she got good reviews for her role as a wife with negative shades. In 2006, she was a judge on Jhalak Dikhlaja, a Sony Entertainment Television dance show based on the original UK show Strictly Come Dancing.

Shetty was once featured in Mani Ratnam's stage show, Netru, Indru, Naalai.