Under the proposal, Kiama Council will buy the 3.3 hectare hospital site from the Illawarra Shoalhaven Local Health District and build a new nursing home and hostel for the council's Blue Haven Aged Care Facility, replacing the current Havilah Place nursing home and hostel.

All the buildings on the hospital site will be demolished except for the heritage-listed Barroul House, which will be renovated and opened to the public, with part of the building having the potential to be used as a cafe.

The project has already attracted an $8 million commitment from the NSW government through the $100 million Illawarra infrastructure fund, established following the lease of Port Kembla.

The $8 million will be shared between Kiama Council and the health service, the health service to use its share to construct a new building at the front of the Bonaira Street site for its services.

The hospital's existing 20-bed inpatient unit that offers "slow stream" rehabilitation to aged care patients, will be initially relocated to Port Kembla then to a redeveloped Shellharbour Hospital.

Kiama Council's Blue Haven nursing home facility already has 82 bed licences, but the new development will allow Blue Haven to activate an additional 52 licences, including 26 dementia care beds. The overall project will also see 52 assisted living units and 20 independent living units developed while eight residential lots at the rear of the property will be sold to help fund the project.

Council general manager Michael Forsyth said plans for the site would need to be approved by the Joint Regional Planning Panel.

"We hope to start work in 2015," he said.

Mr Forsyth said ratepayer funds would not be used on the project with money coming through Blue Haven's reserves, loans to Blue Haven and federal government funds.