The Spaniard has been at the Bernabeu since joining from Malaga for £23m in 2013, and the new deal will run until June 30 2022.
Isco, 25, featured 30 times in Real’s title-winning campaign last season, where he scored 10 times.
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It was a defining season for Isco, as he put to bed rumours of a move abroad and worked his way into Zinedine Zidane’s first-team plans.
The midfielder has also recorded more La Liga assists (30) than any player since joining the club.
The extension follows the news that team-mate Marcelo has also penned a new deal with Real.
The Brazilian left-back signed a new five-year extension, and has won four La Liga titles and three Champions Leagues since moving to Spain from Fluminense in 2007.
"I used to watch Real Madrid on TV," Marcelona told the club's website.
"The club has always been a colossus, but it was only when I arrived that I started to learn about the club's values, that the club helps some of the world's neediest people, and that made see things differently, it is not just a big club, but a real institution.

Marcelo, CL final

Image credit: Eurosport

"Roberto Carlos really helped me when I first arrived, he made things easier for me: he took me home to meet his family, gave me his telephone number…
"That is something quite unexpected when a new player arrives and will be competing for your position in the team. He helped me a great deal and still gives me advice. Apart from being my idol, he has become a friend to me”
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