The midfielder has been linked with a number of Europe's biggest clubs after starring for los Boquerones in their debut season in the Champions League last term.
Manchester City were strongly tipped to sign the 21-year-old, with the Premier League club reportedly keen on reuniting the player with coach Manuel Pellegrini after his arrival from Malaga earlier in June.
But Isco is now set to become Carlo Ancelotti's first signing at the Santiago Bernabeu after Florentino Perez's revelations on Wednesday, with the fee believed to be in the region of €30 million.
"Isco has signed from Malaga and must now pass his medical examination”, the president told Radio Nacional de Espana.
The Spain international revealed earlier in June that he had received offers from both Madrid and Manchester City but hinted on Monday he was set to join the Bernabeu giants.
"Real Madrid are a club that excites me - they are one of the best teams in the world," he said.
Madrid centre-back Sergio Ramos spoke positively about the potential arrival of his Spain team-mate earlier this week.
"Isco is a great player and we always aspire to have the best. It's a joy to hear rumours of a transfer," he told Onda Cero.
Isco scored 12 goals in 47 appearances in all competitions last season.