By David Gritten
BBC News
Israeli forces carried out intense strikes in the area during the raid, which Gaza’s Hamas-run health ministry said killed dozens of people.
This is what we know so far about what happened.
Who are the freed hostages?
They have been named as Louis Har, 70, and Fernando Marman, 60, who were kidnapped from the kibbutz of Nir Yitzhak on 7 October.
Hundreds of Hamas gunmen infiltrated southern Israel that day, killing 1,200 people and taking another 250 back to Gaza as hostages. More than 28,100 people have been killed in Gaza since Israel launched a military campaign in response, according to the territory’s health ministry.
Both of the freed hostages have been taken to the Sheba Medical Center in central Israel, where they were said to be in a good condition.
Videos and photos showed the men walking around and embracing members of their families at the hospital.
What does Israel’s military say?
The first indications that something was taking place in Rafah were a series of intense Israeli strikes, which were reported shortly before 02:00 local time (00:00 GMT) on Monday and caused panic in a city that is sheltering the majority of the estimated 1.7 million Palestinians displaced by the war.
At 00:50, the Israel Defense Forces (IDF) confirmed that they had conducted strikes on “terror targets” in the Shaboura area of Rafah.
One hour and 40 minutes later, the IDF put out a brief statement announcing the rescue of Louis Har and Fernando Marman in a joint operation with the Israel Police’s Yamam special forces unit and the Shin Bet security service.
In the morning, IDF spokesman Rear Adm Daniel Hagari provided more details about what he described as a “complex rescue operation under fire”, for which Israeli commandos had been preparing “for some time”.
“In the early morning, at 01:49, the special forces breached into a building in the heart of Rafah,” he told a news briefing. “On the second floor, Louis and Fernando were held by armed Hamas terrorists, who were present in the building along with terrorists who were in the adjacent buildings.”
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“From the moment of the breach and entry into the apartment, Yamam forces shielded Louis and Fernando with their bodies, initiating a daring battle and heavy exchanges of fire at several locations simultaneously, with many terrorists.”
Adm Hagari added: “By 01:50, aerial fire was activated by the Israeli Air Force and Southern Command, to enable the force’s disengagement and to strike Hamas terrorists in the area.
“At this stage, the forces extracted Louis and Fernando from the apartment and evacuated them under fire, accompanied by IDF forces who provided them protection in the Rafah area until they reached a safe zone.”
A soldier was lightly wounded in the operation, according to Israeli media.”I salute our brave fighters for the daring action that led to their release. Only continued military pressure, until total victory, will bring about the release of all of our hostages,” Prime Minister Benjamin Netanyahu said in a statement.During a week-long ceasefire in late November, 105 Israeli and foreign hostages were released by Hamas. Israel says 134 hostages are still being held, although about two dozen of those are presumed to be dead.