Stigma in society causes harm to people with severe mental illness (SMI) and internalized stigma represents its psychological point of impact. We evaluated the extent of internalized stigma in a sample of outpatients with SMI, using the Internalized Stigma of Mental Illness (ISMI) Scale, developed with consumer input. About a third of the sample reported high levels of internalized stigma. We tested whether internalized stigma predicted increased depressive symptoms and reduced self-esteem at 4-month follow-up, controlling for baseline levels. Depression was predicted by Alienation, Stereotype Endorsement, Social Withdrawal Scales and total ISMI score. Reduced self-esteem was predicted by Alienation. ISMI results were stronger than those for the widely used Devaluation-Discrimination Scale. The finding that alienation further reduces morale speaks to the difficulty of pulling oneself out of this type of vicious cycle without assistance.