The bodies of the second child and an elderly woman have yet to be recovered. The blast occurred on Tuesday night in front of a US-rented villa in a posh locality of Arbil.
The house was believed to have been used by United States intelligence agents. A military spokeswoman initially said it had been a "safe house". Later, military press officers became tight-lipped, confirming only that a blast had taken place in Arbil.
The force of the explosion hurled pieces of the car nearly two kilometers away, blew in compound walls and smashed in doors and windows across the Shorash neighbourhood, witnesses said.
No group claimed immediate responsibility for the attack, which US and Iraqi authorities said was a human bombing that reduced the car to a tangled mass of smouldering metal.
"I saw body parts in a nearby garden; we are sure these body parts are from the bomber," Kurdish plainclothes officer Muhsin Jamil said.
The attack was the latest in a series of car bombings that had previously spared the Kurdish region, hailed by US occupation commanders as one of the invasion’s success stories.
Major James Bullion, a US military spokesman in Arbil, said, "I believe three people were killed - two small children and an elderly women" in the blast.
"I was in my father's home directly in front of the American house, when I saw a big light and then we heard a huge explosion"
A total of 47 people were also wounded in the huge blast, six of them US defence personnel, he said, but declined to say whether the injured Americans were uniformed soldiers or defence department civilian personnel.
Eyewitness Munis Baqir, who had four relatives injured in the blast, said the force blew out doors and windows across the neighbourhood.
"I was in my father's home directly in front of the American house, when I saw a big light and then we heard a huge explosion," Baqir said.
"The blast badly damaged two houses next door to the Americans' house but the American one was not hit badly and just had a window smashed," said Amin Muhsin Ghassan.
He said the large villa was one of several in the neighbourhood that the Pentagon had rented for its staff in the city over the past two months.
"They wear civilian clothes, they don't wear uniforms," he said.
Meanwhile, a US soldier became the 68th to be killed in action in Iraq since the official end of major combat, when his vehicle ran over a homemade bomb northeast of Baghdad on Tuesday afternoon, the military said. Another soldier was wounded.