The town lies about 15 km south of Islamic State’s main Iraqi stronghold of Mosul, which Iraqi forces are trying to take back.
People ran towards a building after an explosion close to the road people were walking down to leave the town.
On Saturday, security forces said they were in control of the center of Hammam al-Alil, although did not say whether the militants had been pushed out completely.
The advance on the southern front comes days after Iraqi Special Forces fought their way into the eastern side of Mosul, taking control of six neighborhoods according to Iraqi officials and restoring a foothold in the city for the first time since the army retreated ignominiously two years ago.
The assault on Hammam al-Alil targeted a force of at least 70 Islamic State fighters, commander of the Mosul operations Major-General Najm al-Jabouri said.
"(The battle) is very important - it's the last town for us before Mosul," Jabouri told reporters.
He said the terrorists were using hundreds of people as human shields, although it was not clear how many civilians were left in the town.
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