Extension Risk


DEFINITION of 'Extension Risk'

The risk of a security's expected maturity lengthening in duration due to the deceleration of prepayments. Extension risk is mainly the result of rising interest rates, and is generally associated with mortgage-related securities. The opposite of extension risk is prepayment risk, which generally occurs in a declining interest rate environment, and is associated with people paying off their loans too quickly.

BREAKING DOWN 'Extension Risk'

As interest rates rise, the likelihood of prepayment decreases as people will be less likely to refinance their homes. If the loans in a pool underlying a mortgage-related security are being prepaid at a slower rate, investors are unable to capitalize on higher interest rates because their investments are locked in at a lower rate for a longer period of time. As interest rates decline, however, the likelihood of prepayment increases because refinancing becomes more attractive. When a loan is refinanced, the original loan gets paid off, and investors then have to invest their proceeds at the new, lower market rate.

  1. Fannie Mae - Federal National Mortgage ...

    A government-sponsored enterprise (GSE) that was created in 1938 ...
  2. Mortgage-Backed Security (MBS)

    A type of asset-backed security that is secured by a mortgage ...
  3. Pass-Through Security

    A pool of fixed-income securities backed by a package of assets. ...
  4. Prepayment Risk

    The risk associated with the early unscheduled return of principal ...
  5. Contraction Risk

    The risk faced by the holder of a fixed income security when ...
  6. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
Related Articles
  1. Economics

    Forces Behind Interest Rates

    Get a deeper understanding of the importance of interest rates and what makes them change.
  2. Investing Basics

    Interest Rates And Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  3. Options & Futures

    20 Investments You Should Know

    To take advantage of all your investing options, you need to know what your choices are. Here we tell you about the diverse features and advantages of 20 different financial instruments.
  4. Savings

    How Parents Can Help Adult Children Buy a Home

    Owning a home isn't easy thanks to stringent lending standards. Thankfully, there's ways parents can help their kids buy a home.
  5. Credit & Loans

    HARP Loan Program: Help for Underwater Mortgages

    If you are underwater on your mortgage, this program may be just what you need to help build up equity in your home.
  6. Insurance

    6 Reasons To Avoid Private Mortgage Insurance

    This costly coverage protects your mortgage lender - not you.
  7. Credit & Loans

    Pre-Qualified Vs. Pre-Approved - What's The Difference?

    These terms may sound the same, but they mean very different things for homebuyers.
  8. Home & Auto

    9 Things You Need To Know About Homeowners' Associations

    Restrictive rules and high fees are just some of the things to watch out for before joining an HOA.
  9. Credit & Loans

    Adjustable Rate Mortgage: What Happens When Interest Rates Go Up

    Adjustable rate mortgages can save borrowers money, but they can't go into it blind. In order to benefit from an ARM, you have to understand how it works.
  10. Taxes

    Before You Visit Your Tax Preparer: Do This

    The earlier you start preparing your tax records and documents, the more likely you are to have a smooth tax return experience – and all the tax benefits you're due.
  1. Do FHA loans have prepayment penalties?

    Unlike subprime mortgages issued by some conventional commercial lenders, Federal Housing Administration (FHA) loans do not ... Read Full Answer >>
  2. Can FHA loans be refinanced?

    Federal Housing Administration (FHA) loans can be refinanced in several ways. According to the U.S. Department of Housing ... Read Full Answer >>
  3. Can FHA loans be used for investment property?

    Federal Housing Administration (FHA) loans were created to promote homeownership. These loans have lower down payment requirements ... Read Full Answer >>
  4. Do FHA loans have private mortgage insurance (PMI)?

    he When you make a down payment from 3 to 20% of the value of your home and take out a Federal Housing Administration (FHA) ... Read Full Answer >>
  5. How many FHA loans can I have?

    Generally, the Federal Housing Administration (FHA) does not insure more than one mortgage per borrower. This is to prevent ... Read Full Answer >>
  6. Are FHA loans assumable?

    Loans insured by the Federal Housing Administration (FHA) on or after Dec. 15, 1989, are assumable by qualifying borrowers. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Take A Flier

    The slang term for a decision to invest in highly speculative investments.
  2. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  3. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  4. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  5. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  6. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
Trading Center