A new study focusing on the Villawood Immigration Detention Centre in Sydney was released as criticism mounted of Canberra's plan to send boatpeople to Malaysia, where detainees can be caned.
Detention is mandatory for asylum seekers who arrive in Australia until their claims are processed, with some remaining locked up for more than a year.
The Australian Human Rights Commission said three apparent suicides at Villawood last year and high rates of self-harm should serve as a warning.
Commission president Catherine Branson said that the uncertainty caused by being held indefinitely was triggering serious mental health issues.
"What we saw at Villawood was the result of the system of mandatory and indefinite detention, where people can see no end in sight because there is no set time limit on the period a person can be held in detention," she said.
Sixty percent of those in detention when the commission visited Villawood had been held for longer than six months, and 45 percent for more than a year.
"We saw people scarred from self-harming. We heard others talk of sleepless nights, days of depression and frequent thoughts of suicide," said Branson.
"The commission has been deeply concerned for some time about the detrimental impacts of prolonged and indefinite detention on people?s mental health and wellbeing."
She added that the concerns had escalated over the past year as thousands more people arrived, usually on boats from Indonesia.
"I urge the government to make greater use of community-based alternatives that are cheaper, more effective and more humane, such as the use of bridging visas or community detention," she said.
Louise Newman, head of the immigration department's detention health advisory group, admitted there were problems.
"Whenever we have in close proximity people killing themselves then that raises very serious issues about the function of the system," she told ABC radio.
Some 8,000 boatpeople have arrived in Australia since the beginning of 2010, and recent riots and rooftop protests have prompted the government to approach Malaysia about taking some for processing.
Canberra plans to send 800 there and in return will accept 4,000 people already assessed to be refugees from Malaysia for resettlement over four years.
The UN High Commissioner for Human Rights this week warned Australia the plan could be illegal, with Malaysia not a signatory to the UN Refugee Convention nor the UN Convention against Torture.
According to Amnesty International, Malaysia canes up to 6,000 detainees a year, claims seized on by critics Thursday.
But Immigration Minister Chris Bowen insisted that he had received assurances that any asylum seekers sent to Malaysia would not be abused.
"Malaysia has agreed to treat any asylum seekers transferred from Australia in line with their human rights," he said in a statement.
"They will not be caned."