The new contract is for two years and a maximum total of $8.1 million, per multiple reports Thursday night.
Williams, who began the season as a little-used, third-string running back, has emerged as an important player for the Chiefs in the past month. Kansas City released starter Kareem Hunt in late November and has played the past two games without the injured Spencer Ware.
Williams responded by rushing for 204 yards in the four games to lead the Chiefs (11-4). He also caught 19 passes and scored five touchdowns.
"Congrats to @TooLoose26 (Damien Williams) on your contract extension with the @Chiefs! Well earned, well deserved," agent Ian Greengross wrote on Twitter.
Williams signed a one-year contract with the Chiefs during the offseason after playing four years as a backup for the Miami Dolphins.