The 21-year-old was a highly rated member of Real Madrid’s Castilla side but was unable to cement a place in their first team.
Palacios featured seven times across all competitions for Real Madrid last season, making his debut under Alvaro Arbeloa, the now Fulham boss.
Fulham have now confirmed the deal, with Palacios signing a deal until the summer of 2031 with the club having an option to extend by a further 12 months.
Like with the signing of Gonzalo Garcia, Fulham state the fee as undisclosed, but it’s been reported they paid Real Madrid €10 million for his services.
Speaking to FFCtv, Palacios said: “I am very emotional to be here. I believe it is the perfect step in my career.
“The Club is showing a lot of trust in me, and I’m going to show it on the pitch.”