The 33-year-old is a fans' favourite at Ewood Park, having graduated from the club's youth set-up before making his debut for the senior side as an 18-year-old in September 1998.
He has represented England at U18 and U20 level, and earned one senior cap when he came off the bench against Portugal in September 2002.
Dunn joined Birmingham ahead of the 2003/4 season but returned to Blackburn in January 2007 and remained a key figure last season, winning the Goal of the Season award for a late equaliser against local rivals Burnley.
Blackburn manager Gary Bowyer is a big fan of Dunn's and is pleased he will be staying on.
"The quality and experience he brings is invaluable to us," said Bowyer. "We all know how much this club means to him."