Traffic through endosomes and lysosomes is controlled by small G-proteins of the Rab5 and Rab7 families. Like humans, Saccharomyces cerevisiae has three Rab5s (Vps21, Ypt52, and Ypt53), and one Rab7 (Ypt7). Here, we elucidate the functional roles and regulation of the yeast Rab5s. Using GFP-tagged cargoes, a novel quantitative multivesicular body (MVB) sorting assay, and electron microscopy, we show that MVB biogenesis and cargo sorting are severely impaired in vps21Δ ypt52Δ double mutants. Ypt53, the third Rab5 paralog, is hardly expressed during normal growth but its transcription is strongly induced by cellular stress through the calcineurin-Crz1 pathway. The requirement for Rab5 activity in stress tolerance facilitated identification of Msb3/Gyp3 as the principal Rab5 GAP (GTPase accelerating protein), and in vitro GAP assays verified that Vps21 is a preferred Gyp3 target. Finally, we demonstrate that Gyp3 spatially restricts active Vps21 to intermediate endosomal compartments by preventing Vps21 accumulation on lysosomal vacuoles. Gyp3 therefore operates as a compartmental insulator that enforces the boundary between penultimate and terminal compartments of the endolysosomal pathway.