DNA hypomethylation is frequently seen in cancer and imparts genomic instability in mouse models and some tissue culture systems. However, the effects of genomic DNA hypomethylation on mutation rates are still elusive. We have developed a model system to analyze the effects of DNA methyltransferase 1 (Dnmt1) deficiency on DNA mismatch repair (MMR) in mouse embryonic stem (ES) cells. We generated sibling ES cell clones with and without functional Dnmt1 expression, containing a stable reporter gene that allowed us to measure the slippage rate at a mononucleotide repeat. We found that Dnmt1 deficiency led to a 7-fold increase in the microsatellite slippage rate. Interestingly, the region flanking the mononucleotide repeat was unmethylated regardless of Dnmt1 status, suggesting that it is not the local levels of DNA methylation that direct the increase in microsatellite instability (MSI). The enhanced MSI was associated with higher levels of histone H3 acetylation and lower MeCP2 binding at regions near the assayed microsatellite, suggesting that Dnmt1 loss may decrease MMR efficiency by modifying chromatin structure.