The Switzerland international moved to the Bundesliga in 2012 after impressing with Basel, and has gone on to make 85 appearances in all competitions.
Xhaka became a regular in Lucien Favre's side last season, and after overcoming a knee ligament injury, has helped them to third place in the league table.
"I feel comfortable at Borussia and am in my third season here," he said. "Therefore, there was never any doubt that I would extend my contract.
"I'm proud and happy to be able to play for Borussia in the future."
The 22-year-old's new deal also contains an option for Monchengladbach to extend it by a further year should he continue to impress, meaning his stay could run until June 2020.
"Granit has developed hugely in his two-and-a-half-years with us and has become one of the most important players on the team," said sporting director Max Eberl.
"We're excited that we have been able to keep him here for the next few years."
