Waterfall Payment

What is a 'Waterfall Payment'

A waterfall payment is a type of payment scheme in which higher-tiered creditors receive interest and principal payments first, while the lower-tiered creditors receive interest and principal payments after the higher-tiered creditors are paid in full. Debtors typically structure these schemes to prioritize the highest principal loans first as they are likely the most expensive.

BREAKING DOWN 'Waterfall Payment'

For example, this type of payment scheme works for a company repaying more than one loan. Assume this company has three operating loans, all with different interest rates. The company makes principal and interest payments on the more costly loan, and makes only interest payments on the remaining two loans. Once the more expensive loan is paid off, the company can make all interest and principal payments on the next, more expensive loan. The process continues until all loans are repaid.

Waterfall Payment Scheme Example

To demonstrate how a waterfall payment scheme works, assume a company has taken loans from three creditors, Creditor A, Creditor B and Creditor C. The scheme is structured so that Creditor A is the highest-tiered creditor while Creditor C is the lowest-tiered creditor. The arrangement for what the company owes each of the creditors is as follows:

Creditor A: is owed a total of $5 million in interest and $10 million in principal.

Creditor B: is owed a total of $3 million in interest and $8 million in principal.

Creditor C: is owed a total of $1 million in interest and $5 million in principal.

Assume in year one the company earns $17 million. It then pays off the entire $15 million owed to Creditor A, leaving it with $2 million to pay off further debts. Since the priority structure is still in place, this $2 million must be applied to Creditor B. Assume the company pays $1 million to Creditor B for interest and $1 million to Creditor B for principal. The result after year one is:

Creditor A: fully paid.

Creditor B: is owed a total of $2 million in interest and $7 million in principal.

Creditor C: is owed a total of $1 million in interest and $5 million in principal.

If in year two, the company earns $13 million, it could then pay off the remaining obligation to Creditor B and begin paying off Creditor C. The result after year two is:

Creditor A: fully paid.

Creditor B: fully paid.

Creditor C: is owed $2 million in principal.

This example was simplified to show the mechanics of a waterfall payment scheme. In reality, some waterfall schemes are structured so minimum interest payments are made to all tiers during each payment cycle.

RELATED TERMS
  1. Creditors' Committee

    A group of people who represent a company's creditors in a bankruptcy ...
  2. Receiver

    A person appointed by a bankruptcy court or secured creditor ...
  3. Notice To Creditors

    A public notice to the creditors and debtors of an estate. The ...
  4. Secured Creditor

    Any creditor or lender that takes collateral for the extension ...
  5. Creditor

    An entity (person or institution) that extends credit by giving ...
  6. Creditor Nation

    A nation with a cumulative balance of payment surplus. A creditor ...
Related Articles
  1. Investing

    What Does a Creditor Do?

    A creditor is a person or entity that loans money or provides goods or services to another entity with the expectation of being paid back in the future.
  2. Personal Finance

    Mortgage Basics: The Amortization Schedule

    By Lisa SmithThe amortization schedule for a residential mortgage is a table that provides a breakdown of the schedule of payments from the loan's first required payment to the loan's final payment. ...
  3. Personal Finance

    Equity Stripping Leaves Creditors Empty-Handed

    Add additional debt to your real estate assets to keep the creditors at bay.
  4. Personal Finance

    7 Tips For The Do-It-Yourself Debt Manager

    Hired gun not in your budget? Learn to be your own credit counselor.
  5. Investing

    Understanding the Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  6. Markets

    Simple Interest Loans: Do They Exist?

    Yes, they do. Here is what they are – and how to use them to your advantage.
  7. Personal Finance

    What is an Amortization Schedule?

    An amortization schedule is a table that shows the amounts of principal and interest that comprise each loan payment.
  8. Markets

    What Does Liquidation Mean?

    Creditors liquidate assets to try and get as much of the money owed to them as possible.
  9. Markets

    How Interest Rates Work On A Mortgage

    A step-by-step explanation of the interest calculations, mortgage types, and how the loan is eventually "retired" – which means paid off.
  10. Investing

    Fighting Back Against Collection Lawsuits

    There are still options available to those being pursued by a creditor.
RELATED FAQS
  1. What are the full rights of creditors in cases of bankruptcy?

    Learn more about corporate bankruptcy and the rights of creditors. Find out how creditors are repaid in the event of bankruptcy ... Read Answer >>
  2. In a corporate liquidation, why are unpaid taxes and wages paid before general creditors ...

    The Bankruptcy Code, section 507, states that when a corporation is liquidated, creditors are paid in a particular order: ... Read Answer >>
  3. Do creditors have the same rights in all 50 US states?

    Learn more about the rights of creditors to pursue their debts; how they may vary from state to state and how they are regulated ... Read Answer >>
  4. Why is more interest paid over the life of a loan when it is capitalized?

    Learn what it means to capitalize interest on a loan. Understand why more interest is paid over the life of a loan when it ... Read Answer >>
  5. How long does it take for items to show up on my credit report?

    Find out how long missed payments, collections and requests for credit take to show up on a credit report and how often most ... Read Answer >>
  6. Who can attend the meeting of creditors (341 hearing)?

    Learn about who may attend and what typically takes place at a 341 creditors hearing. Find out about the role of the trustee ... Read Answer >>
Hot Definitions
  1. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  2. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  3. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  4. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  5. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  6. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
Trading Center