While the sights of Otaru can be done in a day, if you're looking for somewhere to hole up for a few, this is a fantastic choice. Morinoki is an old, sprawling house perched on a stone embankment. Accommodation is in fairly simple mixed-gender dormitories, but there are kitchen and laundry facilities, bilingual staff and super-comfy lounging areas.
The hostel is about a 15-minute walk from JR Otaru Station, and can be a little tricky to find.