The 49-year-old Portuguese penned an initial four-year deal when he took over at Madrid in May 2010.
Mourinho led Madrid to the Copa del Rey crown in his first season in charge and in the campaign just completed he guided the club to their first La Liga title since 2008.
A statement on the Madrid website read: "Real Madrid and Jose Mourinho have reached an agreement to extend the coach's contract with the club until June 30, 2016."
The news will put an to end speculation about Mourinho's future, with reports still linking him with the vacant managerial position at former club Chelsea.
Madrid's title success last season, which ended Barcelona's three-year reign as Spanish champions, saw Mourinho become the first coach to be win the league in Spain, England (Chelsea) and Italy (Inter Milan).
Mourinho is also one of only three coaches to have won the Champions League with separate teams having led Porto to the crown in 2004 and Inter in 2010.
He has also won numerous other trophies during a hugely successful coaching career that began with Benfica in 2000.
Madrid star Cristiano Ronaldo described Mourinho during an interview with newspaper AS as "the best coach in the world".
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Asked who he felt was the better manager out of Mourinho and his former Manchester United boss Sir Alex Ferguson, Ronaldo said: "Ferguson was like a father to me, he taught me many things, and I achieved a very nice part of my career with him.
"Mou, for his part, is the best coach in the world and to be with him now is great to be able to continue growing, it's very good working with him because he's the number one."
Mourinho joined Madrid soon after Inter's Champions League success in 2010, a win which saw the Nerazzurri became the first Italian team to win the treble having also secured the Serie A and Coppa Italia titles.
He became Madrid's ninth coach in six years as the nine-time European champions sought to end Barcelona's domestic and continental dominance.
In his first season in the Bernabeu hotseat, Madrid finished four points behind Barca in La Liga but did manage to beat Pep Guardiola's side in the final of the Copa del Rey - Madrid's first success in that competition since 1993.
Madrid were knocked out of that season's Champions League by their arch rivals, though, following two fractious semi-finals.
Madrid finally got their hands on a 32nd La Liga title in Mourinho's second season in charge, however, after a record-breaking campaign.
They became the first Spanish club ever to reach 100 points in a top-flight season, finishing nine clear of Barca, while their tally of 121 league goals was also a record.
The capital club were unable to add cup success to that league triumph though, as the defence of their Copa del Rey crown was ended at the quarter-final stage by Barca while they were again knocked out of the Champions League in the semi-finals, this time by Bayern Munich.