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.
Explaining ‘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:
Further Reading
- System and method for pricing of a financial product or service using a waterfall tool – patents.google.com [PDF]
- Central counterparty default waterfalls and systemic loss – papers.ssrn.com [PDF]
- Peer-to-peer financing mechanisms to accelerate renewable energy deployment – www.tandfonline.com [PDF]
- Financial data processing system using payment coupons – patents.google.com [PDF]
- The Financial Crisis of 2008 and Subprime Securities – onlinelibrary.wiley.com [PDF]
- A waterfall model of microfinance: innovation and entrepreneurship for sustainable development – www.inderscienceonline.com [PDF]
- Impact of contingent payments on systemic risk in financial networks – link.springer.com [PDF]
