The killings in the Tulkarm refugee camp made it one of Israel's deadliest raids in the occupied territory in weeks.
The Israeli source said all five men were armed. Palestinians said two were members of resistance groups and the other three were unarmed teenagers.
Palestinian Prime Minister Ahmed Qureia condemned the killings as a "brutal crime".
"The brutal crime in Tulkarem shows that Israel does not want calm," Qureia said outside his office.
Qureia also criticized Israel's new plans to confiscate land around the West Bank settlement of Maaleh Adumim for construction of its separation barrier.
"The picture is very dark and very dangerous," Qureia said. "With these actions there will be no room for a viable Palestinian state and no hope for peace."
On Tuesday, Israel finished removing the last of 15,000 settlers and their supporters from 21 enclaves in occupied Gaza and four in the West Bank as part of Prime Minister Ariel Sharon's plan to "disengage" from conflict with Palestinians.
"The brutal crime in Tulkarem shows that Israel does not want calm"
Palestinian Prime Minister
In Wednesday's Tulkarim raid, Israeli soldiers surrounded a house and exchanged fire with fighters inside and outside, witnesses said.
Israeli military officials identified them as top local leaders of the Islamic Jihad, responsible for the last two bombings in Israel - in Tel Aviv in February and Netanya in July.
Jew stabbed to death
Earlier in Jerusalem, a Palestinian stabbed two young ultra-Orthodox Jews in the Old City, police said. One of the victims later died of his wounds. The assailant escaped.
The dead man was a British national while his wounded yeshiva (seminary) classmate was American, police said on Thursday.
Two ultra-Orthodox Jews were
stabbed in the Old City
The 21-year-old victim, Shmuel Matt from north London, was declared dead on arrival at the city's Hadassah hospital on Wednesday night.
The kitchen knife that was used in the killing was recovered at the scene, close to the Jaffa Gate.
It is the first deadly Palestinian attack for three years inside the Old City, part of east Jerusalem which was captured and occupied by Israel in 1967.
Internal security minister Gideon Ezra said it was believed the killing was the work of a lone attacker.
"Without doubt, this attack was committed by a lone Palestinian who was not part of any movement which will make the search for him more difficult," Ezra told army radio.
The killing was the first deadly Palestinian attack since Israel pulled out of the Gaza Strip and four small West Bank settlements.
Also on Wednesday, the Justice Ministry said Israel issued orders to seize Palestinian land to build its separation barrier along a route that would effectively annex the West Bank's largest Jewish settlement to Jerusalem.
Besides objecting to loss of land, Palestinians said that the barrier would cut them off from the part of Jerusalem they claim for a state and reinforce Prime Minister Ariel Sharon's intention to solidify Israel's grip on its main West Bank settlement blocs after the Gaza pullout.
The settlement, Maaleh Adumim, 5km east of Jerusalem in the Judean desert, has about 30,000 residents. Prime Minister Ariel Sharon has said repeatedly that it will remain in Israel even after a final peace accord with the Palestinians.