The 39-year-old comes in as a replacement for Marco Rose, who was sacked last week after the conclusion of the 2021/2022 season.
Dortmund finished eight points behind champions Bayern Munich in the just ended season, failed to qualify from their Champions League group and were dumped out by Rangers at the first hurdle when they dropped into the Europa League.
Dortmund also failed to defend their DFB-Pokal title, getting dumped by Saint Pauli in the round of 16 stage.
Terzic had a previous spell as interim manager at Dortmund in the second half of the 2020/2021 season, winning 20 of his 32 games in charge and leading the club to a DFB-Pokal triumph over RB Leipzig.
"By now, many people should know how important BVB is in my life," said Terzic.
"I would therefore like to sincerely thank Aki Watzke, Michael Zorc and Sebastian Kehl for their great trust and for giving me this great responsibility. We will give everything every day for the success of the team and the entire club."
"We held several intensive discussions with Edin Terzic last weekend and are convinced that this personnel decision is the right one for BVB," said sporting dirctor Sebastian Kehl.
"Edin knows our club, the environment, a large part of the team and knows what adjustments we want to make in order to be able to offer our fans successful football. The 2022/23 season is characterised by a new sporting start. We will drive this forward together with great joy and passion."
