The alternative non-homologous end-joining (NHEJ) machinery facilitates several genomic rearrangements, some of which can lead to cellular transformation. This error-prone repair pathway is triggered upon telomere de-protection to promote the formation of deleterious chromosome end-to-end fusions. Using next-generation sequencing technology, here we show that repair by alternative NHEJ yields non-TTAGGG nucleotide insertions at fusion breakpoints of dysfunctional telomeres. Investigating the enzymatic activity responsible for the random insertions enabled us to identify polymerase theta (Polθ; encoded by Polq in mice) as a crucial alternative NHEJ factor in mammalian cells. Polq inhibition suppresses alternative NHEJ at dysfunctional telomeres, and hinders chromosomal translocations at non-telomeric loci. In addition, we found that loss of Polq in mice results in increased rates of homology-directed repair, evident by recombination of dysfunctional telomeres and accumulation of RAD51 at double-stranded breaks. Lastly, we show that depletion of Polθ has a synergistic effect on cell survival in the absence of BRCA genes, suggesting that the inhibition of this mutagenic polymerase represents a valid therapeutic avenue for tumours carrying mutations in homology-directed repair genes.