Malka Leifer, 54 is wanted by Victorian police on 74 charges of child sexual abuse, including rape.
The former principal of the Addas ultra-orthodox girls school in Melbourne has been in custody since February 12, when Israeli police rearrested her, accusing her of faking mental illness for the past three years in order to avoid extradition to Australia.
Earlier this month there were angry scenes outside a Jerusalem court after an Israeli judge ruled Ms Leifer could be freed from police custody to home detention, following the intercession of a high-profile rabbi.
But Israel's Supreme Court has now upheld an appeal against that decision.
The appeal was lodged by Israel's state attorney.
Former Addas student Dassi Erlich said the ruling was a positive step forward.
"It addresses the concern of many that she is a flight risk and a possible danger to others," she said.
"This ruling will also hopefully limit the stalling tactics of the defence because their client is now sitting in prison awaiting a decision for extradition.
"We feel strengthened and encouraged by this successful appeal and await the next step in this lengthy road towards justice."
Ms Leifer will now stay in prison during the extradition proceedings.
The case will return to court next week.