The scandal-hit car giant will spend 10 billion US dollars (£7.5 billion) either buying back or repairing around 475,000 affected diesel vehicles, while it will compensate US owners with an extra 5,100 US dollars (£3,800) to 10,000 US dollars (£7,500) on top.
Terms of the settlement, revealed in court orders filed with the US District Court in San Francisco, showed that VW will also pay governments 2.7 billion US dollars (£2 billion) for environmental mitigation and spend another 2 billion US dollars (£1.5 billion) for research on zero-emissions vehicles in the US.
It is understood to be the largest consumer class-action settlement against a car firm in US history.
Volkswagen, based in Wolfsburg, Germany, is still facing billions more in fines and penalties, as well as possible criminal charges.
While this settlement relates to two-litre diesel engines, lawyers are still working on settlements for another 80,000 vehicles with three-litre diesel engines
The two-litre settlement requires a judge's approval before it can go into effect and owners can choose to decline Volkswagen's offer and sue the company on their own.
Volkswagen may also be forced to buy back all the two-litre vehicles unless it can find a fix that will bring the cars into compliance with US pollution regulations.
The company has already earmarked £12.7 billion to cover recalls and other costs for 11 million cars sold with the software globally.
The scandal was exposed last year when US regulators revealed that Volkswagen had fitted many of its cars with software to cheat emissions tests.
Investigators found that the cars emitted more than 40 times the legal limit of nitrogen oxide, which can cause respiratory problems.
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