Fonseca, 40, moves to one of Portugal's top clubs after leading unfashionable Pacos to third in the championship last season, their best ever finish which earned them a Champions League qualifying playoff spot.
"We have reached an agreement with Fonseca, who will become the main team coach," the club said in an official statement.
Fonseca will have a tough task to live up to the demands of a club used to winning as much as Porto, who have claimed 14 of the last 20 Portuguese titles.
"I'm highly motivated to keep Porto's winning streak going," Fonseca told Portuguese television shortly after signing his new contract.
He replaces Vitor Pereira who joined Saudi Arabian club Al-Ahli on Sunday after winning the championship in his two seasons at Porto.
Pereira's achievements were not always enough to win over Porto's demanding fans and he was often criticised for the team's failings in the Champions League and domestic cup competitions.
RISKY BET
Just like his predecessor Pereira, who was an assistant coach to Andre Villas-Boas at Porto before getting the top job, Fonseca has little high-level experience before taking on the high-pressure role.
"It is not a risky bet. He is still young but already had more success in his career than previous coaches who came into the job and were successful," said Porto president Jorge Nuno Pinto da Costa.
"I don't know of anyone who picked up a team like Pacos de Ferreira, started the season with the goal of not being relegated, and then took it to Europe, finishing ahead of clubs like Braga and Sporting Lisbon."
Fonseca only started coaching at a professional level two years ago, making it another bold move by Pinto da Costa.
A former centre-back, Fonseca won over pundits in Portugal by moulding Pacos, a club from a tiny town north of Porto, into a very tactically organised side who conceded few goals.
"I like balance in my teams and have them dominate possession. That must be a reality at Porto," Fonseca said.
Seen as a demanding and rigorous coach, he is a self-professed admirer of Arsenal's French manager Arsene Wenger and Benfica's Jorge Jesus.
