On two occasions, in 1171 and 1173, Saladin retreated from an invasion of the Kingdom of Jerusalem. These had been launched by Nur ad-Din, and Saladin hoped that the Crusader kingdom would remain intact, as a buffer state between Egypt and Syria, until Saladin could gain control of Syria as well. Nur ad-Din and Saladin were headed towards open war on these counts when Nur ad-Din died in 1174. Nur ad-Din's heir as-Salih Ismail al-Malik was a mere boy, in the hands of court eunuchs, and died in 1181.

Immediately after Nur ad-Din's death, Saladin marched on Damascus and was welcomed into the city. He reinforced his legitimacy there in the time-honoured way -- by marrying Nur ad-Din's widow. Aleppo and Mosul, on the other hand, the two other largest cities that Nur ad-Din had ruled, were never taken, but Saladin managed to impose his influence and authority on them in 1176 and 1186 respectively. While he was occupied in besieging Aleppo, on May 22, 1176 the elite shadowy assassin group "Hashshashins" attempted to murder him.

While Saladin was consolidating his power in Syria, he usually left the Crusader kingdom alone, although he was generally victorious whenever he did meet the Crusaders in battle. One exception was the Battle of Montgisard on November 25, 1177. He was defeated by the combined forces of Baldwin IV of Jerusalem, Raynald of Chatillon and the Knights Templar. Only one tenth of his army made it back to Egypt.

A truce was declared between Saladin and the Crusader States in 1178. Saladin spent the subsequent year recovering from his defeat and rebuilding his army, renewing his attacks in 1179 when he defeated the Crusaders at the Battle of Jacob's Ford. Crusader counter-attacks provoked further responses by Saladin. Raynald of Chatillon, in particular, harassed Muslim trading and pilgrimage routes with a fleet on the Red Sea, a water route that Saladin needed to keep open. Raynald threatened to attack the holy cities of Mecca and Medina. In retaliation, Saladin besieged Kerak, Raynald's fortress in Oultrejordain, in 1183 and 1184. Raynald responded by looting a caravan of pilgrims on the Hajj in 1185.

In July, 1187, Saladin invaded the Kingdom of Jerusalem. On July 4, 1187, he faced at the Battle of Hattin the combined forces Guy of Lusignan, King consort of Jerusalem, and Raymond III of Tripoli. In the battle alone the Crusader army was largely annihilated by the motivated army of Saladin in what was a major disaster for the Crusaders and a turning point in the history of the Crusades. Saladin captured Raynald de Chatillon and was personally responsible for his execution (according to the chronicle of Ernoul, Raynald had captured Saladin's sister in a raid on a caravan, although this is not attested in Muslim sources). Guy of Lusignan was also captured but his life was spared. Two days after the Battle of Hattin, Saladin ordered the execution of all prisoners of the military orders by beheading. According to Imad al-Din, Saladin watched the executions “with a glad face.” The execution of prisoners at Hattin was not the first by Saladin. On 29 August 1179, Saladin captured the castle at Bait al-Ahazon and approximately 700 prisoners were captured.

Soon Saladin had taken back almost every Crusader city. He recaptured Jerusalem on October 2, 1187, after 88 years of Crusader rule (see Siege of Jerusalem). Saladin initially was unwilling to grant terms of quarter to the occupants of Jerusalem until Balian of Ibelin threatened to kill every Muslim in the city, estimated between 3,000 to 5,000, and to destroy Islam’s holy shrines of the Dome of the Rock and the Aqsa Mosque if quarter was not given. Saladin consulted his council and these terms were accepted. Ransom was to be paid for each Frank in the city whether man, woman, or child. Saladin allowed many to leave without having the required amount for ransom. According to Imad al-Din, approximately 7,000 men and 8,000 women could not make their ransom and were taken into slavery.

Only Tyre held out. The city was now commanded by the formidable Conrad of Montferrat. He strengthened Tyre's defences and withstood two sieges by Saladin. In 1188, Saladin released Guy of Lusignan and returned him to his wife Queen regnant Sibylla of Jerusalem. Both rulers were allowed to seek refuge at Tyre, but were turned away by Conrad, who did not recognise Guy as King. Guy then set about besieging Acre (see Siege of Acre).

Hattin and the fall of Jerusalem prompted the Third Crusade, financed in England by a special "Saladin tithe". This Crusade took back Acre, and Saladin's army met King Richard I of England at the Battle of Arsuf on September 7, 1191 at which Saladin was defeated. Saladin's relationship with Richard was one of chivalrous mutual respect as well as military rivalry; both were celebrated in the courtly romances that developed in Northern Europe. When Richard was wounded, Saladin offered the services of his personal physician. At Arsuf, when Richard lost his horse, Saladin sent him two replacements. Saladin also sent him fresh fruit with snow, to keep his drinks cold. Richard had suggested to Saladin that his sister could marry Saladin's brother - and Jerusalem could be their wedding gift.

The two came to an agreement over Jerusalem in the Treaty of Ramla in 1192, whereby the city would remain in Muslim hands but would be open to Christian pilgrimages; the treaty reduced the Latin Kingdom to a strip along the coast from Tyre to Jaffa.

Saladin died on March 4, 1193 at Damascus, not long after Richard's departure. When they opened Saladin's treasury they found there was not enough money to pay for his funeral; he had given most of his money away in charity. His tomb, located in the Umayyad mosque, is now a major tourist attraction. His tomb is one of the most visited in the Muslim world.