The 20-year-old playmaker was outstanding as Malaga booked their passage to the last 16 of the Champions League and has been linked with a move away from the financially-troubled Andalucian club.
This new deal does not extend his contract beyond its current three-and-a-half-year term, but has improved Isco's wages as well as increasing the amount buyers will have to stump up if they want to sign him.
Sporting director Mario Husillos said: "He's a world-class player and flies the flag for Malaga. If I had to sum up Isco's contract renewal in one word, it would be 'trust', both in terms of the faith we have in him as a player, and the trust he has in Malaga as a club, disregarding his other options and putting us first.
"There have been some informal conversations, as well as more serious talks, with some of the biggest clubs in the world getting in contact every few weeks.
"However Isco has been wise, and has never contemplated a renewal with a future sale in mind; a clause in the contract protects us from this situation.
"Every club in the world does it; Manchester United sold Cristiano (Ronaldo) to Real Madrid, and Atletico (Madrid) sold (Sergio) Kun Aguero to City.
"Life in the footballing world goes on. It's only natural that the major clubs have shown interest in Isco as he's a top-class player. The big players play in the big clubs. Isco has renewed his contract to remain here at Malaga."
Isco told the club's official website www.malagacf.es: "I'm so grateful for the faith Malaga has in me, and I have every confidence in the team, and my ability to keep growing as a player.
"I'm 20 years old and continue to mature and improve every day. I'm a very ambitious person and always striving for improvement, although my contract renewal has no relation to my growth as a player."