Supporters of the opposition Popular Party are celebrating strong gains Prime Minister Jose Luis Rodriguez Zapatero conceded defeat but ruled out early general elections.
Voting took place amid mass protests against high unemployment and the government's handling of the economy.
Young demonstrators holding sit-ins in Madrid and other cities said rallies would continue for another week.
Mr Zapatero said three years of economic crisis had taken their toll.
"It destroyed thousands of jobs. It is a crisis that had profound effects on citizens' morale. I know that many Spaniards suffer great hardship and fear for their futures," he said.
"Today, without doubt, they expressed their discontent," he added.
However, he vowed to pursue job-creating reforms until the end of his mandate. At this point, a general election must be held by March of next year.
Bastions fall Jubilant PP supporters celebrated outside their party headquarters in Madrid as the final votes were being counted.
The party was heading to victory in virtually all 13 regional governments up for grabs, including Castilla-La Mancha where the Socialists have always held power.
In municipal elections, the PP won by about two million votes, compared to its victory margin of 150,000 in 2007.
The Socialist party also lost bastions such as the town halls in Barcelona and Seville.
Prime Minister Zapatero's government has been struggling to overcome recession and create jobs.
Prime Minister Zapatero says voters expressed their discontent at Spain's economic hardship Meanwhile, thousands of young protesters remain camped out in squares across the country.
What began as a sit-in in Madrid's central Puerta del Sol square a week ago has turned into a national protest movement popularly known as 15-M.
About 30,000 people were estimated to have occupied the central square in the run-up to the vote.
The protests, which have also taken place in cities including Barcelona, Valencia, Seville and Bilbao, have so far been peaceful.
Demonstrators defied a government ban on political protests on the eve of the election.
On Sunday protesters in Puerta del Sol voted to stay in the square until at least 29 May.
"Our zeal to press on is at maximum level," said spokesman Francisco Minarro, 32.
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