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by Rakesh Waghela

18.8 Waterfall mathematics

The waterfall is the deterministic algorithm that allocates a borrower’s payment across multiple components. Mis-allocation creates audit issues and borrower disputes. This page is the algorithm with concrete examples.

Standard waterfall (board-approved)

Section titled “Standard waterfall (board-approved)”
Order:
1. Penal charges outstanding (charges_outstanding.penal)
2. Other fees outstanding (late, bounce, servicing, etc.)
3. Interest accrued
4. Principal outstanding

Some agreements specify different order; the loan agreement governs. Most NBFC standard agreements follow above order.

Algorithm

Section titled “Algorithm”
def allocate(payment_amount, loan):
    remaining = payment_amount
    allocation = {}


    # 1. Penal charges
    penal = loan.charges_outstanding.penal
    apply = min(remaining, penal)
    allocation['penal'] = apply
    loan.charges_outstanding.penal -= apply
    remaining -= apply


    # 2. Other fees (in agreement order)
    for fee_type in ['late', 'bounce', 'servicing', 'other']:
        fee = loan.charges_outstanding[fee_type]
        apply = min(remaining, fee)
        allocation[fee_type] = apply
        loan.charges_outstanding[fee_type] -= apply
        remaining -= apply
        if remaining == 0: return allocation


    # 3. Interest accrued
    interest = loan.accrued_interest
    apply = min(remaining, interest)
    allocation['interest'] = apply
    loan.accrued_interest -= apply
    remaining -= apply
    if remaining == 0: return allocation


    # 4. Principal
    principal = loan.principal_outstanding
    apply = min(remaining, principal)
    allocation['principal'] = apply
    loan.principal_outstanding -= apply
    remaining -= apply


    if remaining > 0:
        # Excess — apply as advance toward future EMI or refund
        allocation['advance'] = remaining


    return allocation

Worked Example 1 — Simple EMI repayment, clean

Section titled “Worked Example 1 — Simple EMI repayment, clean”

Loan: ₹10 lakh term loan, ₹51,306 EMI. EMI #5 due 2026-05-01, paid on 2026-05-01.

State at payment:

  • Principal outstanding: ₹8,32,000
  • Accrued interest till 2026-04-30 (since last EMI on 2026-04-01): ₹14,560
  • Charges outstanding: ₹0

Payment received: ₹51,306.

Allocation:

Penal: ₹0
Fees:  ₹0
Interest: ₹14,560
Principal: 51,306 - 14,560 = ₹36,746

Post-allocation:

  • Principal outstanding: ₹8,32,000 - ₹36,746 = ₹7,95,254
  • Accrued interest: ₹0 (carried over to next month’s accrual)
  • Charges: ₹0

Worked Example 2 — EMI with bounce + late charge

Section titled “Worked Example 2 — EMI with bounce + late charge”

Same loan. EMI #5 due 2026-05-01 bounced on NACH 2026-05-01. Borrower paid on 2026-05-11 (10 days late).

State at payment:

  • Principal outstanding: ₹8,32,000
  • Accrued interest till 2026-05-10 (40 days since last EMI on 2026-04-01): ₹17,895 (10 extra days of accrual on ₹8.32L)
  • Charges:
    • Bounce charge (NACH bounce on 2026-05-01): ₹1,000 + GST 180 = ₹1,180
    • Late charge (10 days late): 2% × 51,306 = ₹1,026, but min ₹500 max ₹5,000. So ₹1,026 + GST 185 = ₹1,211.

Payment received: ₹51,306 (borrower pays standard EMI; insufficient to clear all).

Allocation:

Penal: ₹0
Fees:
  Bounce + GST: ₹1,180
  Late + GST: ₹1,211
  → fees total ₹2,391
Interest: ₹17,895
Principal: 51,306 - 2,391 - 17,895 = ₹31,020

Post-allocation:

  • Principal: ₹8,32,000 - ₹31,020 = ₹8,00,980
  • Charges: ₹0 (cleared)
  • Accrued interest: ₹0

Note: borrower paid ₹51,306 but principal reduced by only ₹31,020 instead of expected ₹36,746 (had it been on time and no bounce). The difference (₹5,726) went to charges + extra interest from delay.

Worked Example 3 — Underpayment (partial)

Section titled “Worked Example 3 — Underpayment (partial)”

Same loan. Borrower pays only ₹30,000 against ₹51,306 due.

Allocation:

Penal: ₹0
Fees: ₹0 (none outstanding)
Interest: ₹14,560 (full)
Principal: 30,000 - 14,560 = ₹15,440

Post-allocation:

  • Principal: ₹8,16,560 (vs expected ₹7,95,254)
  • Accrued interest: ₹0 (cleared by what borrower paid)
  • Shortfall: ₹51,306 - ₹30,000 = ₹21,306 remains in arrears.

Loan starts accruing late charge on the shortfall after grace period.

Worked Example 4 — Penal charge present

Section titled “Worked Example 4 — Penal charge present”

Borrower has revolving line ₹40 lakh. Over-limit by ₹3 lakh for 15 days (penal accrued = ₹247). EMI of ₹15,000 (interest only on current month) due.

State at payment:

  • Penal: ₹247 + GST 44 = ₹291
  • Interest accrued: ₹15,000
  • Principal outstanding: ₹43 lakh (over-limit)

Payment of ₹20,000:

Allocation:

Penal: ₹291
Fees: ₹0
Interest: ₹15,000
Principal: 20,000 - 291 - 15,000 = ₹4,709

Post-allocation:

  • Principal: ₹42,95,291 (still over-limit; another penal charge accrues until borrower brings under ₹40 lakh)
  • Penal: ₹0
  • Interest: ₹0

Worked Example 5 — Prepayment

Section titled “Worked Example 5 — Prepayment”

Loan: ₹10 lakh, ₹51,306 EMI, 12 months remaining. Borrower prepays ₹4 lakh on 2026-05-15 (mid-month).

State at payment:

  • Principal outstanding: ₹6,00,000
  • Accrued interest from last EMI date 2026-05-01 to 2026-05-15 (14 days): ₹4,830 (at 21% on ₹6L)
  • No charges.

Payment: ₹4,00,000.

Allocation:

Penal: ₹0
Fees: ₹0
Interest: ₹4,830
Principal: 4,00,000 - 4,830 = ₹3,95,170

Post-allocation:

  • Principal: ₹6,00,000 - ₹3,95,170 = ₹2,04,830
  • Schedule re-computation triggered:
    • New EMI on reduced principal at original rate + remaining 12 months.
    • OR: keep same EMI, fewer months.
    • (Per borrower’s election at prepayment.)

Worked Example 6 — Foreclosure (floating-rate MSME — no charge)

Section titled “Worked Example 6 — Foreclosure (floating-rate MSME — no charge)”

Loan: ₹10 lakh floating-rate term loan to MSME borrower. Borrower wants to foreclose on 2026-05-15 with ₹6,00,000 outstanding.

State:

  • Principal: ₹6,00,000
  • Accrued interest to date: ₹4,830
  • Charges: ₹0

Foreclosure amount = ₹6,04,830 (no foreclosure charge per RBI 2014 floating-rate MSME rule).

Borrower pays ₹6,04,830.

Allocation:

Interest: ₹4,830
Principal: ₹6,00,000

Loan closed. NOC issued.

Worked Example 7 — Co-lent loan repayment

Section titled “Worked Example 7 — Co-lent loan repayment”

Co-lent loan ₹25 lakh (originator 20%, partner 80%). Borrower’s EMI of ₹40,000 paid.

State:

  • Originator’s share principal: ₹4,80,000
  • Partner’s share principal: ₹19,20,000
  • Total principal: ₹24,00,000
  • Originator’s accrued interest: ₹8,400
  • Partner’s accrued interest: ₹33,600

Payment: ₹40,000.

Allocation (split by share ratio per agreement):

Originator's allocation (20%):
   Interest: min(8000, 8400) = ₹8,000
   Principal: ₹0 (only what remains after interest)


Partner's allocation (80%):
   Interest: min(32000, 33600) = ₹32,000
   Principal: ₹0

Hmm, full EMI was meant to cover both interest and a tiny principal piece. Let me redo with correct logic:

Total EMI ₹40,000:

  • Interest split per share: Originator ₹8,400 interest, Partner ₹33,600 interest = ₹42,000 total. But EMI is ₹40,000 — actually structured to be slightly more than just interest.

In practice, the waterfall on co-lent applies to the combined view first then attributes to lender shares:

Combined:
  Interest: ₹42,000 — but only ₹40,000 paid.
  Allocate interest pro-rata to lenders.


Each lender's share:
  Interest received (pro-rata) = (lender's interest / total interest) × ₹40,000
  Originator: (8400/42000) × 40,000 = ₹8,000
  Partner: (33600/42000) × 40,000 = ₹32,000


Principal received: ₹0 in this payment.


Lender ledgers:
  Originator: interest received ₹8,000; arrears interest ₹400; principal unchanged
  Partner: interest received ₹32,000; arrears interest ₹1,600; principal unchanged

Settlement is daily — each lender receives their share via the daily co-lending settlement run.

What the LMS must enforce

Section titled “What the LMS must enforce”
  • Waterfall deterministic — same payment, same loan state, same allocation always.
  • Per agreement — different agreements may have variants (e.g., bullet products may have “interest first, then principal” only without penal/fee complexity).
  • Co-lending share-aware — allocation respects share split.
  • GST on fees allocated separately from fee itself.
  • Auditable — each allocation event posted to loan_event with full breakdown.

Edge case: payment exceeds outstanding

Section titled “Edge case: payment exceeds outstanding”

If borrower over-pays (rare but happens):

  • All outstanding cleared.
  • Excess held as advance against future EMI.
  • OR refunded per borrower’s option.

Edge case: payment with disputed charges

Section titled “Edge case: payment with disputed charges”

If borrower disputes a charge:

  • Holding pattern — payment held in suspense until dispute resolved.
  • Or: allocate per waterfall and reverse the disputed charge separately later.

Edge case: multi-draw revolving line repayment

Section titled “Edge case: multi-draw revolving line repayment”

When borrower repays into a revolving line with multiple active draws:

  • Identify which draw the repayment applies to (often borrower-specified; otherwise FIFO).
  • Allocate within that draw per waterfall.
  • Or: apply to line-level (treat all draws as combined) and then attribute pro-rata.

Policy choice; documented in agreement.

Section titled “Related”