Mesenchymal stem cells (MSCs) are multipotent stem cells with the capacity of self-renewal, homing, and low immunogenicity. These distinct biological characteristics have already shown immense potential in regenerative medicine. MSCs also possess immunomodulatory properties that can maintain immune homeostasis when the immune response is over-activated or under-activated. The secretome of MSCs consists of cytokines, chemokines, signaling molecules, and growth factors, which effectively contribute to the regulation of immune and inflammatory responses. The immunomodulatory effects of MSCs can also be achieved through direct cell contact with microenvironmental factors and immune cells. Furthermore, preconditioned and engineered MSCs can specifically improve the immunomodulation effects in diverse clinical applications. These multifunctional properties of MSCs enable them to be used as a prospective therapeutic strategy to treat immune disorders, including autoimmune diseases and incurable inflammatory diseases. Here we review the recent exploration of immunomodulatory mechanisms of MSCs and briefly discuss the promotion of the genetically engineered MSCs. Additionally, we review the potential clinical applications of MSC-mediated immunomodulation in four types of immune diseases, including systemic lupus erythematosus, Crohn’s disease, graft-versus-host disease, and COVID-19.