Hyperpolarization-activated cation channels of the HCN gene family contribute to spontaneous rhythmic activity in both heart and brain. All four family members contain both a core transmembrane segment domain, homologous to the S1-S6 regions of voltage-gated K+ channels, and a carboxy-terminal 120 amino-acid cyclic nucleotide-binding domain (CNBD) motif. Homologous CNBDs are responsible for the direct activation of cyclic nucleotide-gated channels and for modulation of the HERG voltage-gated K+ channel--important for visual and olfactory signalling and for cardiac repolarization, respectively. The direct binding of cyclic AMP to the cytoplasmic site on HCN channels permits the channels to open more rapidly and completely after repolarization of the action potential, thereby accelerating rhythmogenesis. However, the mechanism by which cAMP binding modulates HCN channel gating and the basis for functional differences between HCN isoforms remain unknown. Here we demonstrate by constructing truncation mutants that the CNBD inhibits activation of the core transmembrane domain. cAMP binding relieves this inhibition. Differences in activation gating and extent of cAMP modulation between the HCN1 and HCN2 isoforms result largely from differences in the efficacy of CNBD inhibition.