The Ballon d'Or winner in 2018 won a sixth Champions League crown as well as a fourth LaLiga title with Real last season.
Modric's previous contract expired at the end of the 2023-24 season but the Croatian told fans he would return next season when they were celebrating their Champions League triumph which extended Real's record to 15 European Cups.
No player has won more titles with Real Madrid than Modric, who has lifted 26 trophies since he joined the Spanish giants in 2012.
The veteran player was widely expected to retire, especially after his long-time midfield partner Toni Kroos, 34, announced his retirement at the end of the season.
Modric also had no plans to hang up his boots on the international stage despite Croatia's early exit from the recently concluded European Championship, where they were eliminated after the group stage.
"I'd like to keep playing forever but there probably will come a time when I must hang up my boots. I'll keep playing on, but I don't know for how much longer," said Modric, who has 178 caps for Croatia.
