Extension is the mirror image of prepayment-risk and the more dangerous half. Borrowers with a 3% mortgage will never refinance into a 7% market, so the pool stops paying down, duration rises, and the investor is stuck with a longer bond in a selloff.
The combination of contraction when rates fall and extension when rates rise is exactly what negative-convexity means. Portfolio hedging against it requires buying options or dynamically shortening duration, both of which cost money.
Example: a pool has expected average life of 4.5 years and duration 3.9. Yields rise 100 basis points, average life extends to 8 years and duration rises to 6.4. The realised loss is well beyond the 3.9% a static duration estimate predicted.
Related: prepayment-risk, negative-convexity, mortgage-backed-security, effective-duration, duration