The former Burnley, Bolton Wanderers and Wigan Athletic boss takes over from Dominic Kinnear, whose spell in charge of the Texas franchise came to an end at the conclusion of this past season.
Kinnear could only lead the Dynamo to an eighth-placed finish in the Eastern Conference in his final campaign in charge and will now take over at the San Jose Earthquakes.
The task of turning around the fortunes of the two-time MLS Cup champions has been handed to Coyle, who guided Burnley to promotion to Premier League in 2009 and took Bolton to the FA Cup semi-finals in 2011.
And the Scot – out of football since his departure from Wigan in December last year - is relishing the challenge of coaching in the United States.
"First and foremost I'm thankful for the opportunity to come to the Houston Dynamo," Coyle told Dynamo's official website.
"It is nice to be wanted by a fantastic club and I feel we have a great opportunity to put a team on the pitch that is pleasing on the eye and can win games.
"I've been watching Houston Dynamo for many years and I know the atmosphere of the supporters. The league is thriving and the opportunity to join a big club like the Dynamo is very exciting for me.
"It's going to be one of the biggest leagues in world football and anybody in the game wants to be involved at a high level. MLS certainly is and I think it'll continue to progress.
"For me it was a fantastic challenge. I've watched MLS extensively, back home we get live feeds and highlights so I certainly know all the teams in the league.
"When I sat with [club president] Chris [Canetti] I just knew straight away. It was a similar feeling to the one I got when I sat with [co-owner] Brendan Flood at Burnley. That feeling that they're not only knowledgeable people but really good men, which is so important."