diff --git a/README.md b/README.md
index 38faa059..c97ce673 100644
--- a/README.md
+++ b/README.md
@@ -31,6 +31,15 @@ steps:
     terraform_version: "1.1.7"
 ```
 
+A specific version of Terraform CLI can be installed using a version file:
+
+```yaml
+steps:
+- uses: hashicorp/setup-terraform@v3
+  with:
+    terraform_version_file: ".tool-versions"
+```
+
 Credentials for HCP Terraform ([app.terraform.io](https://app.terraform.io/)) can be configured:
 
 ```yaml
@@ -251,10 +260,24 @@ The action supports the following inputs:
    for available range specifications). Examples are: `"<1.2.0"`, `"~1.1.0"`, `"1.1.7"` (all three installing
    the latest available `1.1` version). Prerelease versions can be specified and a range will stay within the
    given tag such as `beta` or `rc`. If no version is given, it will default to `latest`.
+- `terraform_version_file` - (optional) The path to a file containing terraform version. Supported file types are `.tool-versions` or `.terraform-version`. See more details in [about version-file](#Terraform-version-file).
 - `terraform_wrapper` - (optional) Whether to install a wrapper to wrap subsequent calls of
    the `terraform` binary and expose its STDOUT, STDERR, and exit code as outputs
    named `stdout`, `stderr`, and `exitcode` respectively. Defaults to `true`.
 
+### Terraform version file
+
+If the `terraform_version_file` input is specified, the action will extract the version from the file and install it.
+
+Supported files names are `.tool-versions` or `.terraform-version`.
+In `.tool-versions` file, terraform version should be preceded by the terraform keyword (e.g., `terraform 1.13.0`).
+The `.tool-versions` file supports version specifications in accordance with Semantic Versioning ([semver](https://semver.org/)) and [Semver Ranges](https://www.npmjs.com/package/semver#ranges).
+The `.terraform-version` file supports version specifications as explained in the `terraform_version` input.
+
+If both `terraform_version` and `terraform_version_file` inputs are provided, the `terraform_version` input will be used.
+
+If the file contains multiple versions, only the first one will be recognized.
+
 ## Outputs
 
 This action does not configure any outputs directly. However, when you set the `terraform_wrapper` input
diff --git a/action.yml b/action.yml
index ea170be1..7ddd20e5 100644
--- a/action.yml
+++ b/action.yml
@@ -11,7 +11,9 @@ inputs:
     required: false
   terraform_version:
     description: 'The version of Terraform CLI to install. Instead of full version string you can also specify constraint string starting with "<" (for example `<1.13.0`) to install the latest version satisfying the constraint. A value of `latest` will install the latest version of Terraform CLI. Defaults to `latest`.'
-    default: 'latest'
+    required: false
+  terraform_version_file:
+    description: 'The path to the `.terraform-version` file. See examples of supported syntax in README file'
     required: false
   terraform_wrapper:
     description: 'Whether or not to install a wrapper to wrap subsequent calls of the `terraform` binary and expose its STDOUT, STDERR, and exit code as outputs named `stdout`, `stderr`, and `exitcode` respectively. Defaults to `true`.'
diff --git a/lib/setup-terraform.js b/lib/setup-terraform.js
index 87e7575c..5155931d 100644
--- a/lib/setup-terraform.js
+++ b/lib/setup-terraform.js
@@ -121,14 +121,70 @@ credentials "${credentialsHostname}" {
   await fs.writeFile(credsFile, creds);
 }
 
+async function getVersionFromFileContent (versionFile) {
+  if (!versionFile) {
+    return;
+  }
+
+  let versionRegExp;
+  const versionFileName = path.basename(versionFile);
+  if (versionFileName === '.tool-versions') {
+    versionRegExp = /^(terraform\s+)(?<version>[^\s]+)$/m;
+  } else if (versionFileName === '.terraform-version') {
+    versionRegExp = /(?<version>[^\s]+)/;
+  } else {
+    return;
+  }
+
+  try {
+    const content = fs.readFileSync(versionFile).toString().trim();
+    let fileContent = '';
+    if (content.match(versionRegExp)?.groups?.version) {
+      fileContent = content.match(versionRegExp)?.groups?.version;
+    }
+    if (!fileContent) {
+      return;
+    }
+    core.debug(`Version from file '${fileContent}'`);
+    return fileContent;
+  } catch (error) {
+    if (error.code === 'ENOENT') {
+      return;
+    }
+    throw error;
+  }
+}
+
+// get the Terraform version from the action inputs
+async function getTerraformVersion (versionInput, versionFile) {
+  const DEFAULT_VERSION = 'latest';
+
+  let version = versionInput;
+  if (!versionInput && !versionFile) {
+    core.info(`Set default value for version to ${DEFAULT_VERSION}`);
+    version = DEFAULT_VERSION;
+  }
+
+  if (!version && versionFile) {
+    version = await getVersionFromFileContent(versionFile);
+    if (!version) {
+      throw new Error(`No supported version was found in file ${versionFile}`);
+    }
+  }
+  return version;
+}
+
 async function run () {
   try {
     // Gather GitHub Actions inputs
-    const version = core.getInput('terraform_version');
+    const versionInput = core.getInput('terraform_version', { required: false });
+    const versionFile = core.getInput('terraform_version_file', { required: false });
     const credentialsHostname = core.getInput('cli_config_credentials_hostname');
     const credentialsToken = core.getInput('cli_config_credentials_token');
     const wrapper = core.getInput('terraform_wrapper') === 'true';
 
+    const version = await getTerraformVersion(versionInput, versionFile);
+
     // Gather OS details
     const osPlatform = os.platform();
     const osArch = os.arch();
diff --git a/test/setup-terraform.test.js b/test/setup-terraform.test.js
index 57cda0f6..86708083 100644
--- a/test/setup-terraform.test.js
+++ b/test/setup-terraform.test.js
@@ -44,12 +44,14 @@ describe('Setup Terraform', () => {
 
   test('gets specific version and adds token and hostname on linux, amd64', async () => {
     const version = '0.1.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -86,12 +88,14 @@ describe('Setup Terraform', () => {
 
   test('gets specific version and adds token and hostname on windows, 386', async () => {
     const version = '0.1.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -131,12 +135,14 @@ describe('Setup Terraform', () => {
 
   test('gets latest version and adds token and hostname on linux, amd64', async () => {
     const version = 'latest';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -174,12 +180,14 @@ describe('Setup Terraform', () => {
 
   test('gets latest version matching specification adds token and hostname on linux, amd64', async () => {
     const version = '<0.10.0';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -217,12 +225,14 @@ describe('Setup Terraform', () => {
 
   test('gets latest version matching tilde range patch', async () => {
     const version = '~0.1.0';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -259,12 +269,14 @@ describe('Setup Terraform', () => {
 
   test('gets latest version matching tilde range minor', async () => {
     const version = '~0.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -301,12 +313,14 @@ describe('Setup Terraform', () => {
 
   test('gets latest version matching tilde range minor', async () => {
     const version = '~0';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -343,12 +357,14 @@ describe('Setup Terraform', () => {
 
   test('gets latest version matching .X range ', async () => {
     const version = '0.1.x';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -385,12 +401,14 @@ describe('Setup Terraform', () => {
 
   test('gets latest version matching - range ', async () => {
     const version = '0.1.0 - 0.1.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -427,12 +445,14 @@ describe('Setup Terraform', () => {
 
   test('fails when metadata cannot be downloaded', async () => {
     const version = 'latest';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -449,12 +469,14 @@ describe('Setup Terraform', () => {
 
   test('fails when specific version cannot be found', async () => {
     const version = '0.9.9';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -471,12 +493,14 @@ describe('Setup Terraform', () => {
 
   test('fails when CLI for os and architecture cannot be found', async () => {
     const version = '0.1.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -509,12 +533,14 @@ describe('Setup Terraform', () => {
 
   test('fails when CLI cannot be downloaded', async () => {
     const version = '0.1.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
 
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken);
 
@@ -547,6 +573,7 @@ describe('Setup Terraform', () => {
 
   test('installs wrapper on linux', async () => {
     const version = '0.1.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
     const wrapperPath = path.resolve([__dirname, '..', 'wrapper', 'dist', 'index.js'].join(path.sep));
@@ -559,6 +586,7 @@ describe('Setup Terraform', () => {
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken)
       .mockReturnValueOnce('true');
@@ -591,6 +619,7 @@ describe('Setup Terraform', () => {
 
   test('installs wrapper on windows', async () => {
     const version = '0.1.1';
+    const versionFile = '';
     const credentialsHostname = 'app.terraform.io';
     const credentialsToken = 'asdfjkl';
     const wrapperPath = path.resolve([__dirname, '..', 'wrapper', 'dist', 'index.js'].join(path.sep));
@@ -603,6 +632,7 @@ describe('Setup Terraform', () => {
     core.getInput = jest
       .fn()
       .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
       .mockReturnValueOnce(credentialsHostname)
       .mockReturnValueOnce(credentialsToken)
       .mockReturnValueOnce('true');
@@ -632,4 +662,205 @@ describe('Setup Terraform', () => {
     expect(ioMv).toHaveBeenCalledWith(`file${path.sep}terraform.exe`, `file${path.sep}terraform-bin.exe`);
     expect(ioCp).toHaveBeenCalledWith(wrapperPath, `file${path.sep}terraform`);
   });
+
+  test('gets version from .tool-versions file', async () => {
+    const version = '';
+    const versionFile = '.tool-versions';
+    const credentialsHostname = 'app.terraform.io';
+    const credentialsToken = 'asdfjkl';
+
+    core.getInput = jest
+      .fn()
+      .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
+      .mockReturnValueOnce(credentialsHostname)
+      .mockReturnValueOnce(credentialsToken);
+
+    tc.downloadTool = jest
+      .fn()
+      .mockReturnValueOnce('file.zip');
+    tc.extractZip = jest
+      .fn()
+      .mockReturnValueOnce('file');
+
+    os.platform = jest
+      .fn()
+      .mockReturnValue('linux');
+
+    os.arch = jest
+      .fn()
+      .mockReturnValue('amd64');
+
+    nock('https://releases.hashicorp.com')
+      .get('/terraform/index.json')
+      .reply(200, json);
+
+    fs.readFileSync = jest
+      .fn()
+      .mockReturnValueOnce('terraform 0.1.1');
+
+    const versionObj = await setup();
+    expect(versionObj.version).toEqual('0.1.1');
+  });
+
+  test('gets version from version if both (version and .tool-versions file) are set', async () => {
+    const version = '0.1.0';
+    const versionFile = '.tool-versions';
+    const credentialsHostname = 'app.terraform.io';
+    const credentialsToken = 'asdfjkl';
+
+    core.getInput = jest
+      .fn()
+      .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
+      .mockReturnValueOnce(credentialsHostname)
+      .mockReturnValueOnce(credentialsToken);
+
+    tc.downloadTool = jest
+      .fn()
+      .mockReturnValueOnce('file.zip');
+
+    tc.extractZip = jest
+      .fn()
+      .mockReturnValueOnce('file');
+
+    os.platform = jest
+      .fn()
+      .mockReturnValue('linux');
+
+    os.arch = jest
+      .fn()
+      .mockReturnValue('amd64');
+
+    nock('https://releases.hashicorp.com')
+      .get('/terraform/index.json')
+      .reply(200, json);
+
+    fs.readFileSync = jest
+      .fn()
+      .mockReturnValueOnce('terraform 0.10.0');
+
+    const versionObj = await setup();
+    expect(versionObj.version).toEqual('0.1.0');
+  });
+
+  test('gets latest version using empty inputs for versions', async () => {
+    const version = '';
+    const versionFile = '';
+    const credentialsHostname = 'app.terraform.io';
+    const credentialsToken = 'asdfjkl';
+
+    core.getInput = jest
+      .fn()
+      .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
+      .mockReturnValueOnce(credentialsHostname)
+      .mockReturnValueOnce(credentialsToken);
+
+    tc.downloadTool = jest
+      .fn()
+      .mockReturnValueOnce('file.zip');
+
+    tc.extractZip = jest
+      .fn()
+      .mockReturnValueOnce('file');
+
+    os.platform = jest
+      .fn()
+      .mockReturnValue('linux');
+
+    os.arch = jest
+      .fn()
+      .mockReturnValue('amd64');
+
+    nock('https://releases.hashicorp.com')
+      .get('/terraform/index.json')
+      .reply(200, json);
+
+    const versionObj = await setup();
+    expect(versionObj.version).toEqual('0.10.0');
+  });
+
+  test('gets version from .terraform-version file', async () => {
+    const version = '';
+    const versionFile = '.terraform-version';
+    const credentialsHostname = 'app.terraform.io';
+    const credentialsToken = 'asdfjkl';
+
+    core.getInput = jest
+      .fn()
+      .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
+      .mockReturnValueOnce(credentialsHostname)
+      .mockReturnValueOnce(credentialsToken);
+
+    tc.downloadTool = jest
+      .fn()
+      .mockReturnValueOnce('file.zip');
+    tc.extractZip = jest
+      .fn()
+      .mockReturnValueOnce('file');
+
+    os.platform = jest
+      .fn()
+      .mockReturnValue('linux');
+
+    os.arch = jest
+      .fn()
+      .mockReturnValue('amd64');
+
+    nock('https://releases.hashicorp.com')
+      .get('/terraform/index.json')
+      .reply(200, json);
+
+    fs.readFileSync = jest
+      .fn()
+      .mockReturnValueOnce('0.1.1');
+
+    const versionObj = await setup();
+    expect(versionObj.version).toEqual('0.1.1');
+  });
+
+  test('fails when unsupported terraform version file', async () => {
+    const version = '';
+    const versionFile = 'unsupported-file';
+    const credentialsHostname = 'app.terraform.io';
+    const credentialsToken = 'asdfjkl';
+
+    core.getInput = jest
+      .fn()
+      .mockReturnValueOnce(version)
+      .mockReturnValueOnce(versionFile)
+      .mockReturnValueOnce(credentialsHostname)
+      .mockReturnValueOnce(credentialsToken);
+
+    tc.downloadTool = jest
+      .fn()
+      .mockReturnValueOnce('file.zip');
+    tc.extractZip = jest
+      .fn()
+      .mockReturnValueOnce('file');
+
+    os.platform = jest
+      .fn()
+      .mockReturnValue('linux');
+
+    os.arch = jest
+      .fn()
+      .mockReturnValue('amd64');
+
+    nock('https://releases.hashicorp.com')
+      .get('/terraform/index.json')
+      .reply(200, json);
+
+    fs.readFileSync = jest
+      .fn()
+      .mockReturnValueOnce('0.10.0');
+
+    try {
+      await setup();
+    } catch (e) {
+      expect(core.error).toHaveBeenCalled();
+    }
+  });
 });