Isco has played in all three of Real's La Liga fixtures so far this season, and started in Tuesday night's Champions League win over APOEL.
Isco's previous deal was due to expire next summer but the new contract will keep the Spain global at the Bernabeu stadium until June 2022.
Isco eventually remained at Real but his future came under bigger scrutiny during the first part of last season as the player grew frustrated with the lack of playing time.
The last time Real Sociedad had such a good start in the Spanish league, it went on to win the title.
They travel to high-flying Real Sociedad in Sunday's late kickoff without the suspended duo of left back Marcelo and Ronaldo, who serves the final match of a five-game domestic ban for pushing a referee.
Isco had been linked with a transfer away from Real for years, as he failed to establish himself as a regular starter in the star-studded side.
Isco had already proven his talent before his arrival to the Bernabeu stadium. Isco won a spot in starting Zinedine Zidane during last campaign, where y reached ir best level and helped team to achievement of LaLiga and Champions League.
He also starred for Spain, scoring twice as they defeated Group G rivals Italy 3-0 earlier this month to move within a victory of 2018 FIFA World Cup qualification.
The Wales worldwide will be the only member of his team's "BBC" strike force available for Sunday evening's La Liga game at early leaders Real Sociedad, with Madrid missing the suspended Cristiano Ronaldo and injured Karim Benzema.