The unfolded protein response (UPR) detects the accumulation of unfolded proteins in the endoplasmic reticulum (ER) and adjusts the protein-folding capacity to the needs of the cell. Under conditions of ER stress, the transmembrane protein Ire1 oligomerizes to activate its cytoplasmic kinase and ribonuclease domains. It is unclear what feature of ER stress Ire1 detects. We found that the core ER-lumenal domain (cLD) of yeast Ire1 binds to unfolded proteins in yeast cells and to peptides primarily composed of basic and hydrophobic residues in vitro. Mutation of amino acid side chains exposed in a putative peptide-binding groove of Ire1 cLD impaired peptide binding. Peptide binding caused Ire1 cLD oligomerization in vitro, suggesting that direct binding to unfolded proteins activates the UPR.