The former principal of an ultra-Orthodox girls school in Melbourne has been ruled mentally unfit to face extradition and had her home detention lifted in a move that has shocked and deeply concerned Australian officials.

Key points: Judge rules Malka Leifer unfit to face extradition

Judge rules Malka Leifer unfit to face extradition She is wanted by Victorian police for charges of indecent assault, rape

She is wanted by Victorian police for charges of indecent assault, rape Leifer's house arrest will be lifted

Leifer's house arrest will be lifted Victims disappointed by move

A Jerusalem judge has ruled that Malka Leifer is not mentally fit to face extradition proceedings to Australia.

Leifer is wanted by Victorian police on 74 charges of indecent assault and rape allegedly involving girls at the Adass Israel School in Melbourne.

In 2008, after accusations were first raised against her, the former principal fled to Israel with her family in the middle of the night, allegedly with the help of senior members of Melbourne's secretive Adass community.

For two years, she has managed to evade 10 extradition proceedings, claiming that she faces panic attacks whenever scheduled court dates arise and that she is too unwell to attend court.

On Thursday, a long-awaited report from the district psychiatrist agreed she was mentally unwell and Judge Amnon Cohen ruled she would not face an extradition hearing until she had completed psychiatric treatment that could go on for years.

Her house arrest in Israel will be lifted, allowing her to walk free for the first time since she was arrested by Israeli police at the request of Australia in August 2014.

However, the Israeli prosecutor's office has been given 72 hours to appeal the lifting of the house arrest and the ABC understands it will do this.

Australian officials shocked by decision

Leifer's treatment in a clinic in a Jerusalem ultra-Orthodox neighbourhood will begin next week and would initially last for six months, but during that time she is only required to receive five treatments.

A committee will then assess whether she is fit to stand trial. If she is continually found to be mentally unfit she may evade her extradition trial indefinitely.

The Australian Embassy in Tel Aviv says it is studying the judgement closely and assessing its implications, but the ABC understands Australian officials were shocked and deeply concerned by the decision.

Ambassador Dave Sharma said the Embassy was discussing the next step with the Israeli State Attorney's office.

"We are committed to seeing this woman extradited to Australia to face these very serious child sex abuse charges," he said.

"We are determined to be patient and persevere to this end with the view to seeing her extradited."

At a hearing in February, Israeli prosecutor Avital Ribner Oron challenged Leifer's medical claims, telling the judge she believed the former principal was "faking" her illness in order to get rid of the case.

At the same hearing, Judge Amnon also noted concerns about Leifer's behaviour that were raised by the head of the psychiatric department of a hospital she attended in January.

"There is a sharp difference between her behaviour in the [psychiatric] department, among groups, during telephone conversations with family and in her formal examinations," documents tabled to the court said.

These doubts over her medical claims made today's decision unexpected.

'The decision speaks for itself'

State prosecutor Avital Ribner-Oron was visibly unhappy in court after the decision was announced but said she could not make a comment about the case.

Yehuda Fried is a lawyer for Malka Leifer. ( ABC News: Sophie McNeill )

In a statement, the Israeli State Attorney's office told the ABC: "The decision speaks for itself, we have no official response".

In a civil case against the Adass Israel School and Leifer, last September a Melbourne judge awarded one of the alleged victims $1.27 million in damages.

In April, one of Leifer's alleged victims, Rebecca (not her real name), spoke out for the first time, outraged the former principal had been avoiding extradition proceedings.

Today, she said she was shocked and horrified to learn of the latest developments.

"How can it be that she is not fit enough to stand trial but she only has to go to the psychologist once a month?" Rebecca asked.

"It's mindboggling. I've lost all hope that she will face justice."

Rebecca questioned who had funded Leifer's long legal battle to avoid extradition.

"She's clearly got good lawyers. They are paying anything to make sure she never faces trial. She has powerful connections," she said.

The victims are devastated: advocate

Australian-Israeli victim advocate Manny Waks is the head of a global body to advocate on behalf of victims of child sexual abuse from within the Jewish community.

He said he was outraged by the decision.

"Some of Leifer's alleged victims feel devastated and completely let down by Israel's legal system," he said.

"They are also now fearful of bumping into her on the street."

Mr Waks said that if Leifer was so unwell that she could not even attend court, she needed to be in a psychiatric ward.

"And when she's well enough, she should be brought before the court to face the long-overdue extradition hearing," he said.

"This will ensure both justice for the alleged victims and the safety of Israel's children."

He said it was "disappointing" the Israeli authorities rejected Australia's offer to assess Leifer and look after her psychiatric needs in Australia.

Adass community 'got rid of' Leifer

Shlomo Abelesz, a leader in Melbourne's Adass community, told 7.30 that when the school board heard the allegations of abuse it decided not to report the claims to the police.

"They called an urgent meeting and they called in Mrs Leifer, who denied everything," Mr Abelesz said.

"They decided that there's too much, you know, the suspicion of guilt is pretty high, and they said, 'out of here', and they got rid of her."

Space to play or pause, M to mute, left and right arrows to seek, up and down arrows for volume. Watch Duration: 6 minutes 20 seconds 6 m Adass community devastated Malka Leifer won't face extradition

The Adass community "got rid of" Leifer immediately. She flew out of Melbourne at midnight, taking her family of seven to Israel.

Zeddy Lawrence, editor of Australian Jewish News, said his community should not have double standards when it comes to extradition.

"We still campaign to get Nazi war criminals brought to justice and they're often cases where somebody is accused of committing war crimes where people will say, or their families will say, or defenders will say: 'They're too, old they're too frail, they're too ill, what's the point after all this time?'

"It would be shocking to think that the same standard was being brought to bear here, where people are saying: 'Oh, Malka Leifer is too ill.'

"No, she has to face justice, however ill she may be, ultimately she has to stand trial for the crimes she is accused of committing."