Dreyer was born illegitimate in Copenhagen, Denmark. His birth mother was an unmarried Scanian maid named Josefine Bernhardine Nilsson, and he was put up for adoption by his birth father, Jens Christian Torp, a married Danish farmer living in Sweden who was his mother's employer. He spent the first two years of his life in orphanages until his adoption by a typographer named Carl Theodor Dreyer, and his wife, Inger Marie (née Olsen). He was named after his adoptive father, but in accordance with Danish practice, there is no "Senior" or "Junior" added to their names to distinguish them from each other.
His adoptive parents were emotionally distant and his childhood was largely unhappy. He later recalled that his parents "constantly let me know that I should be grateful for the food I was given and that I strictly had no claim on anything, since my mother got out of paying by lying down to die." But he was a highly intelligent school student, who left home and formal education at the age of sixteen. He dissociated himself from his adoptive family, but their teachings were to influence the themes of many of his films.
Dreyer was ideologically conservative. According to David Bordwell, "As a youth he belonged to the Social Liberal party, a conservative group radical only in their opposition to military expenditures...'Even when I was with Ekstrabladet,' Dreyer recalled, 'I was conservative...I don't believe in revolutions. They have, as a rule, the tedious quality of pulling development back. I believe more in evolution, in the small advances.'"
Dreyer died of pneumonia in Copenhagen at age 79. The documentary Carl Th. Dreyer: My Metier contains reminiscences from those who knew him.
As a young man, Dreyer worked as a journalist, but he eventually joined the film industry as a writer of title cards for silent films and subsequently of screenplays. He was initially hired by Nordisk Film in 1913.