The town, so the story goes, owes its founding to a few hot dogs. These hounds were dearly loved by a courageous barefooted Franciscan friar, Juan de San Miguel, who started a mission in 1542 near an often-dry river, 5km (3.1mi) from the present town. One day, the dogs wandered off from the mission, and were later found reclining at the spring called El Chorro, south of the present town. This site was so superior that the mission was moved.

San Miguel was then central Mexico's most northern Spanish settlement. Tarascan and Tlaxcalan allies of the Spanish were brought to help pacify the local Otomí and Chichimecs - San Miguel was barely surviving the fierce Chichimec resistance. In 1555, a Spanish garrison was established to protect the new road from Mexico City to the silver center of Zacatecas. Spanish ranchers settled in the area, and it grew into a thriving commercial center known for its knives, textiles and horse tack. It also became home to some of Guanajuato's wealthy silver barons.

San Miguel's favorite son, Ignacio Allende, was born here in 1779. He became a fervent believer in the need for Mexican independence and was a leader of a Querétaro-based conspiracy that set December 8, 1810 as the date for an armed uprising. After initial successes, Allende, Hidalgo and other rebel leaders were captured in 1811 in Chihuahua. Allende was summarily executed. When Mexico finally achieved independence in 1821, he was recognized as a martyr and, in 1826, the town was renamed San Miguel de Allende.

The Escuela de Bellas Artes was founded in 1938, and the town started to take on its current character when David Alfaro Siqueiros began mural-painting courses that attracted artists of every persuasion. The Instituto Allende opened in 1951, also attracting foreign students. Many were US citizens seeking to escape the conformity of post-WWII USA.

During the 1960s, San Miguel became a center for American expatriatism. Notably, it was a popular destination for Ken Kesey, author of One Flew Over the Cuckoo's Nest, and the circle of people that graduated towards him (known as his 'Merry Pranksters'). Beat writer Neal Cassady, who was characterized as Dean Moriarty in Jack Kerouac's novel On the Road, was found dead beside the railway tracks between San Miguel and Celaya in 1968. He had been attending a party in San Miguel.

In recent years, San Miguel has attracted many more foreign residents. When the extent of this surge was reported in the media in 2006, there was a rush of residential sales and housing development construction. A major new supermarket was built at one end of the city and, a little further away, a large shopping mall opened. Many residents, both local and foreign, have protested against this rapid development. To combat increasing traffic, a 700-space city parking lot has been built away from the historic center.

San Miguel has applied for a UNESCO World Heritage Site listing; this will be decided in 2008. In the meantime, officials are endeavoring to preserve the city center.