Hydroxyl functionalized carbon dots (H-CDs) were prepared by monoesterification of ethylene glycol. The H-CDs exhibit a narrow size distribution of 1–4 nm and enhanced photoluminescent (PL) intensity due to an increased amount of electron donor hydroxyl groups. According to fluorescence spectra, the H-CDs exhibit a high sensitivity to Fe³⁺ with a detection limit of 2.56 nM, which is superior to the detection limit of CDs (7.4 μM). The quenching fluorescence is primarily controlled by the formation of a chelate compound based on the complexation between Fe³⁺ and the hydroxyl on the surface of the H-CDs. Furthermore, we demonstrate that paper impregnated with H-CDs exhibits a high sensitivity to Fe³⁺ by fluorescence quenching. In the future, the modified CDs can be developed for high sensitivity fluorescent probes by optimizing the chemical structures and microstructures.