Extension Risk

AAA

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.

INVESTOPEDIA EXPLAINS '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.




RELATED TERMS
  1. Fannie Mae - Federal National Mortgage ...

    A government-sponsored enterprise (GSE) that was created in 1938 ...
  2. Contraction Risk

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

    The amount charged, expressed as a percentage of principal, by ...
  4. Mortgage-Backed Security (MBS)

    A type of asset-backed security that is secured by a mortgage ...
  5. Companion Bond

    A class of tranche found in a planned amortization class (PAC) ...
  6. Planned Amortization Class (PAC) ...

    A class of tranche in a planned amortization class (PAC) bond ...
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. Credit & Loans

    Are APRs different in different countries?

    Learn about the term APR and how it is used in the United States and other countries. Explore why different lenders charge different APRs.
  5. Credit & Loans

    What loans do and don't have an APR?

    Learn about what annual percentage rates (APR) are and what they mean. Explore different fixed and variable APRs charge by different lenders.
  6. Credit & Loans

    What are the pros and cons of owning an equity REIT versus a mortgage REIT?

    Learn about investing in equity, mortgage and hybrid REITs. Explore the different strategies REITs employ to generate income and create dividends.
  7. Credit & Loans

    What is the debt ratio for an FHA loan?

    Borrowing through the Federal Housing Administration requires individuals to provide proof of income as well as information relating to total outstanding debt.
  8. Home & Auto

    What factors should I consider when shopping for the best mortgage lender?

    Comparing lenders to obtain the best mortgage loan requires research and willingness to shop around for the best loan to fit individual needs.
  9. Credit & Loans

    Buying A House? Avoid These 7 Mistakes

    Owning your own home gives you a feeling of independence that renting can’t offer, and there are big financial benefits, too.
  10. Professionals

    Should Your Retiring Clients Pay Off A Mortgage?

    Should your retiring clients pay off their mortgages? It's more complicated than 'yes' or 'no,' so here's a quick guide.

You May Also Like

Hot Definitions
  1. Treasury Bond - T-Bond

    A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest ...
  2. Weight Of Ice, Snow Or Sleet Insurance

    Financial protection against damage caused to property by winter weather specifically, damage caused if a roof caves in because ...
  3. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  4. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  5. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
  6. Federal Funds Rate

    The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution ...
Trading Center