Osorno's first decent hostel is run by a bilingual snowboarder who named the hostel after her stint near Burlington, Vermont. It's everything you want in a hostel: friendly, clean and well equipped (as well as some things you don't want: creaky old floors mixed with rowdiness means it can get sleep-deprivingly loud).
From the long-distance bus station, walk two blocks south to Juan MacKenna, five blocks east to Buenos Aires and one and a half blocks south to Toribio Medina.