The increased tumor incidence in telomerase null mice suggests that telomere dysfunction induces genetic instability. To test this directly, we examined mutation rate in the absence of telomerase in S. cerevisiae. The mutation rate in the CAN1 gene increased 10- to 100-fold in est1Δ strains as telomeres became dysfunctional. This increased mutation rate resulted from an increased frequency of terminal deletions. Chromosome fusions were recovered from est1Δ strains, suggesting that the terminal deletions may occur by a breakage-fusion-bridge type mechanism. At one locus, chromosomes with terminal deletions gained a new telomere through a Rad52p-dependent, Rad51p-independent process consistent with break-induced replication. At a second locus, more complicated rearrangements involving multiple chromosomes were seen. These data suggest that telomerase can inhibit chromosomal instability.