Their parents reportedly woke to find their Geelong home filled with smoke at around 8am on Thursday morning.
A fire, believed to be caused by a toy falling on an electric heater, had broken out in the room where they were sleeping.
"The parents have noticed smoke coming from the front bedroom," Detective Senior Sergeant Mark Guthrie told media, according to the ABC.
"We're not too sure at this stage how long the fire's been smouldering in the room … it was noticed at 8:00am and the heater had been turned on at some stage in the morning.
"The father has gone into the room and has removed the children and he and his wife have taken both of the children to hospital and when they got to hospital they were pronounced dead."
Emergency crews were called to the home and the parents rushed to hospital with the two girls while neighbours looked after their six-month-old baby.
The baby, who had been asleep in another room, was also treated for smoke inhalation.
The family have reportedly lived in Australia for four years after fleeing Afghanistan as refugees.
Neighbour and friend Dr Charlie Corke, who wasn’t home at the time, described the incident as “everybody’s worst nightmare”.
“They’re a lovely family,” he told AAP. “They’re well-liked and I hope there’ll be adequate support in the community.”
Police are investigating the cause of the fire, however, it is not understood to be suspicious and are urging people to take care when using heaters in the home.