Peters announced the decision on Instagram and will have two years of eligibility remaining at Illinois.
"I want to thank the University of Michigan for the opportunity to represent the winged helmet," Peters said on Instagram. "The memories and friendships I made along this journey will last a lifetime. I am excited to announce that I will be going to grad school and playing my last two years at the University of Illinois."
Because he has graduated from Michigan, Peters will be eligible to play immediately and could factor in to the quarterback race for the Illini.
Quarterback M.J. Rivers announced he was transferring from Illinois in the beginning of May, and Rivers was right in the thick of the battle for the starting job. His departure leaves an opportunity for Peters to compete with redshirt freshmen Coran Taylor and Matt Robinson, neither of whom have started at Illinois.
The former ESPN 300 quarterback signed with Michigan in the 2016 class out of Avon High School in Avon, Indiana. He redshirted his freshman year and started only four games at Michigan while completing 58 passes for 680 yards, four touchdowns and three interceptions.
Peters is joining an Illinois team that has not been shy about taking transfers to help fill holes on the roster. Former USC wide receiver Josh Imatorbhebhe on Monday announced his transfer to Illinois; he'll join former teammates Trevon Sidney and Oluwole Betiku Jr, who also are transferring to the Illini.
The staff added Alabama offensive lineman Richie Petitbon, and former Georgia tight end Luke Ford transferred in to Illinois as well, but he was denied a waiver to gain immediate eligibility and will have to sit out the 2019 season.