Tykes boss David Flitcroft said earlier this month that he was reluctant to offer the 28-year-old anything longer than a one-year deal, but Steele will now stay with Barnsley until the summer of 2015.
Steele told the club's offical website: "These things take time to get sorted, but now it's done I'm over the moon and I'm very happy to have a new two-year deal.
"I'm excited about this project and I like the whole plan that the club has to move forward. It's the most exciting contract I've signed in my time at the club.
"Seeing the signings of all the players that did so well last season was important to me. It gives real stability. Often at the end of a season I have been used to a lot of players going out and new ones coming in, but this year it hasn't been the case.
"I think it's very important to get that level of consistency which we have now. It feels like we can carry on where we left off from last season.
"I didn't ever see myself leaving although other clubs were interested. There is only one club that I support and that is Barnsley."
Steele, who started out at Peterborough and sealed a £500,000 switch to Manchester United in 2002 at the age of 17, spent two years at West Brom before joining Barnsley after an initial loan spell in May 2008. He has made nearly 200 first-team appearances for the Tykes.