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 principal payments only after the higher-tiered creditors are paid back in full. Debtors typically structure these schemes into such traunches to prioritize the highest-principal loans first because they are also likely the most expensive.

For example, this type of plan works best for a company repaying more than one loan. Assume this company has three operating loans, each with different interest rates. The company makes principal and interest payments on the costliest loan, and makes only interest payments on the remaining two. Once the most 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.

BREAKING DOWN 'Waterfall Payment'

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.

  1. Charging Order

    A charging order is a court-ordered creditor lien on the distributions ...
  2. Unsecured Creditor

    An unsecured creditor is an individual or institution that lends ...
  3. Floor Limit

    A floor limit is a purchase amount over which further authorization ...
  4. Article 9

    Article 9 is an article under the Uniform Commercial Code (UCC) ...
  5. Satisfaction and Release

    When a debt that is due under a court judgement has been paid ...
  6. Temporary Default

    Temporary default occurs when a debt issuer fails to meet loan ...
Related Articles
  1. Personal Finance

    Fighting Back Against Collection Lawsuits

    There are still options available to those being pursued by a creditor.
  2. Personal Finance

    Unemployed? 5 Smart Ways to Get Control of Debt

    When you're unemployed and barely making ends meet, smart debt advice can help you stay on top of your payments and protect your credit rating.
  3. Investing

    Equity Stripping Leaves Creditors Empty-Handed

    Add additional debt to your real estate assets to keep the creditors at bay. Learn about debt- and corporate-entity-based strategies for protecting your assets.
  4. Personal Finance

    Debt Collection: Know Your Rights

    Learn about the debt collection process so you know how to handle it if it happens to you.
  5. Personal Finance

    Refinance Vs. Debt Restructuring: What's Best For Your Credit Score?

    Discover key differences between refinancing and restructuring debt in regard to terms, the negotiation process and effect on credit scores.
  6. Insights

    The Difference Between Restructuring & Refinancing

    Refinancing and restructuring are very different debt reorganization processes to avoid bankruptcy.
  7. Personal Finance

    How To Get Rid Of Your Ex-Spouse's Debts

    Divorce is hard enough without one spouse abusing the financial end of the relationship. Find out how to protect your finances.
  8. Financial Advisor

    Corporate bankruptcy: An overview

    When public company files for corporate bankruptcy, the bondholders are first in line to receive their share back. Equity holders on the other hand, are second in line to bondholders when a corporate ...
  1. Do I still owe debt collectors for a debt that's past the statute of limitations ...

    Learn more about the statutes of limitations that govern certain personal debts and why you maintain obligations as a debtor ... Read Answer >>
Trading Center