There are now three hostels in Arugam Bay offering a mix of dorm beds and private rooms. Little Lagoon hostel is located at the quieter northern end of the bay near the lagoon. The Long Hostel and Arugam Hostel (formerly the YMCA) are located nearer the surf points at the busier southern end of town.
Little Lagoon Hostel
The best option if you like it quiet and chilled as it takes a maximum of 12 people. The hostel is an old Sri Lankan home consisting of three ac bedrooms each with 2 bunk-beds. It has a kitchen and a garden with chairs and hammocks for relaxing. It consistently scores high for cleanliness and friendliness. See Little Lagoon Hostel on Booking.com.
The Long Hostel
A mix of ac and non-ac private double and twin rooms and 4-bed and 6-bed dorm rooms. Extremely popular due to the location in the busy part of town and a short walk across the road to the beach. This hostel also scores very highly for cleanliness and for being well-organised. See The Long Hostel on Booking.com.
Formerly the YMCA and located under the Siam View, it is the oldest hostel in Arugam Bay. They impose a minimum 7 night stay and try to build more of a community of longer term guests. It is the only hostel on the beach side of the main road. However, it does seem to suffer from a lack of organisation, overall cleanliness and maintenance according to online reviews. See Arugam Hostel on Booking.com.
The reality is that paying 1500-2500LKR for a dorm bed is overpriced in Arugam Bay. There are plenty of smaller guesthouses where you can have your own private room with bathroom for the same amount. The positive side is that the first two hostels are always busy and a great place to meet other travellers.