Hill, 43, returned for a second spell with Dale when he succeed John Coleman in January, having previously led them to a first promotion for 41 years in 2010 before leaving for Barnsley the following summer.
The manager's initial agreement ran until the end of the season but on Thursday he committed himself to the npower League Two outfit until 2016.
"It is fair to say that you don't realise what you've got until it is gone and that is certainly the case with Keith," said Rochdale chairman Chris Dunphy on his club's official website.
"In the period of time that he has been back at the club we have all seen a change in the way that the team plays football and Keith's hard work and commitment is now bearing fruit with positive results on the pitch.
"We're all starting to watch Rochdale with a smile on our faces."
Rochdale will begin next season in the fourth tier but are finishing the current campaign with a flourish and head to Oxford this weekend defending a six-match unbeaten run.