Vertebrate telomeres are transcribed into telomeric repeat-containing RNA (TERRA) that associates with telomeres and may be important for telomere function. Here, we demonstrate that telomeres are also transcribed in Saccharomyces cerevisiae by RNA polymerase II (RNAPII). Yeast TERRA is polyadenylated and stabilized by Pap1p and regulated by the 5' to 3' exonuclease, Rat1p. rat1-1 mutant cells accumulate TERRA and harbor short telomeres because of defects in telomerase-mediated telomere elongation. Overexpression of RNaseH overcomes telomere elongation defects in rat1-1 cells, indicating that RNA/DNA hybrids inhibit telomerase function at chromosome ends in these mutants. Thus, telomeric transcription combined with Rat1p-dependent TERRA degradation is important for regulating telomerase in yeast. Telomere transcription is conserved in different kingdoms of the eukaryotic domain.