The new agreement adds two years to Kovac's previous contract, rewarding the Croatian for the progress Dortmund have made since he took charge in early 2025.
Dortmund were languishing in 11th place when Kovac arrived, but he turned their season around and secured Champions League qualification on the final day of the campaign. They subsequently finished runners-up to Bayern Munich last season.
Kovac believes the club have established a strong foundation for further improvement.
"Together, we've set a clear course for development and laid important foundations for the future," he said.
"We want to build on that. We have a clear vision of how we play soccer, how we perform as a team, and what it takes to achieve our goals."
The contract extension comes as Dortmund continue to challenge near the top of the Bundesliga. After five league matches, they are second behind Freiburg on goal difference.
Kovac's immediate focus is Wednesday's Champions League encounter with Bodo/Glimt, as Dortmund look to maintain their momentum in domestic and European competition.