Work on Kirk Road is expected to get underway in mid-January.
The funding has been allocated from the Housing Infrastructure Fund, which aims to support the delivery of new housing through financial assistance.
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The road upgrade is being carried out as part of a housing development in the area by social housing provider LINK.
The scheme, which is awaiting planning consent for 300 homes in the first phase, forms part of the Dunbeg and Ganavan Masterplan.
Chair of the Oban, Lorn and the Isles Area Committee, Cllr Elaine Robertson, said: "I'm delighted that the Scottish Government has agreed funding to upgrade Kirk Road.
"The improvements will make a real difference to the present residents and the local community, and will enable this very important housing development, part of the Dunbeg masterplan, to be progressed."
(LM)
