Lysosomal accumulation of cholesterol is a hallmark of Niemann Pick type C (NPC) disease caused by mutations primarily in the lysosomal membrane protein NPC1. NPC1 contains a transmembrane sterol-sensing domain (SSD), which is supposed to regulate protein activity upon cholesterol binding, but the mechanisms underlying this process are poorly understood. Using atomistic simulations, we show that in the absence of cholesterol in the SSD, the luminal domains of NPC1 are highly dynamic, resulting in the disengagement of the NTD from the rest of the protein. The disengaged NPC1 adopts a flexed conformation that approaches the lipid bilayer, and could represent a conformational state primed to receive a sterol molecule from the soluble lysosomal cholesterol carrier NPC2. The binding of cholesterol to the SSD of NPC1 allosterically suppresses the conformational dynamics of the luminal domains resulting in an upright NTD conformation. The presence of an additional 20% cholesterol in the membrane has negligible impact on this process. The additional presence of an NTD-bound cholesterol suppresses the flexing of the NTD. We propose that cholesterol acts as an allosteric effector, and the modulation of NTD dynamics by the SSD-bound cholesterol constitutes an allosteric feedback mechanism in NPC1 that controls cholesterol abundance in the lysosomal membrane.