A new package was unveiled by Peter Peacock, Education Minister, who visited the college on Monday.
The college, which enrols around 1,100 students each year, is one of three in Scotland that are "unincorporated", and therefore not funded on the same formula as others in further education.
Its finances have been regarded as perilous for some time and it received a one-off grant of pound;900,000 to stabilise its position. Ministers then called in PricewaterhouseCoopers to carry out an audit on the college's finance and governance.
The deal will see the college receive an extra pound;755,000 in the current year, rising to pound;800,000 in 2007-08. Ministers will then aim to provide an additional pound;950,000 in each of the following two years.
These sums are on top of the pound;1.7 million in core grants for further and higher education which the college receives from the Scottish Funding Council and the Department of Tourism, Culture and Sport.
Mr Peacock made it clear ministers had been swayed by economic as well as cultural and educational arguments. "Sabhal Mor Ostaig is a high-quality, unique institution embracing education, arts and culture and economic development activity," he said. "It is a key centre for ideas and innovation within Gaelic."
The college has a key role to play in promoting the Gaelic language and in supporting the economy of the Highlands and Islands, he added.
Norman Gillies, principal of Sabhal Mor Ostaig, said the funding package was "a recognition that, to keep us going as we are, we need more core funding, and a recognition that what we do is of national as well as local importance."
Professor Gillies added that the PricewaterhouseCoopers review had endorsed "our holistic approach to maintaining and revitalising Gaelic". It had also acknowledged the college's good educational leadership and high-quality teaching.
The college would now look to reduce costs of around pound;150,000 for accommodation and catering.
None of the extra funding is earmarked for teacher training, although Sabhal Mor Ostaig has been criticised for its failure to do more in this field. Ministers made clear, following a report on Gaelic teacher recruitment last November, that they expected the college to become involved.
Professor Gillies said it was preparing to do so, "possibly next year".
The college has made a start by running an online course for Gaelic-speaking teachers who wish to retrain as Gaelic-medium teachers.