The German international would have been able to leave Chelsea on another free transfer this summer but instead has committed himself to the club for another 12 months.
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A Chelsea statement said: "Michael has been a key member of our team for three years so we are naturally very happy that we have agreed the extension."
Speaking after Chelsea's FA Cup final victory over Everton last weekend Ballack said he was confident the club is able to catch Manchester United and reclaim the Premier League title they won twice under former manager Jose Mourinho.
He said: "We know what we can do and that we have a strong squad.
"This year we lost too many points at home and we need that consistency. I am sure we are at the same level.
"You can see that in our performances, especially in European games. We went to the final last year and this year we had one foot in the final and we were really unlucky to go out, so you can't say the club is going in the wrong direction."