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Finance

What is Residual Income?

By Sheri Cyprus
Updated Feb 15, 2024
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There are two definitions of residual income. In the context of loan qualifications, it is the money a person has left after monthly payment obligations such as housing costs and taxes; or the extra amounts of operating income a business has over the regular minimum of controllable operating assets. Another common definition of residual income is any income generated through indirect involvement with something. This is more properly called passive income. Rental income, royalties, website revenues and portfolio dividends are all means of generating this kind of income.

As a Loan Qualification

Many financial institutions have specific criteria related to residual income that a person or business has to meet before a loan will be granted. For instance, if a family were applying for a home loan of $75,000 US Dollars (USD), the financial institution may require them to have at least $1,000 USD residual income every month. The amount may depend on other factors as well, such as the applicant's debt-to-income ratio, the region in which he or she is applying for the loan, the type of loan applied for, and the individual regulations of the financial institution. To calculate this type of income, a person generally just takes their total income for a specified period of time, and then subtracts all the things that have to be paid in that time period. Anything left over is considered residual.

Passive Income

Sources

There are many different sources of the passive type of residual income, but some of the most popular and profitable ones are investment portfolio incomes, rental income, and royalties from intellectual property, like book sales or patent licensing fees. Many people also get passive income in the form of a pension, but this varies from company to company as well as regionally. A form of passive income that has become particularly popular in the early 21st century is Internet revenue. This includes things like earning money on websites through advertising or number of page views. Other popular types of passive income include franchising and limited partnerships in businesses

Risks

The idea of residual or passive income is popular since the potential of earning extra money without additional time or effort is possible. This strategy can be extremely profitable, but there is no guarantee of success, and it is generally not advisable to base an entire income on passive sources, at least until it proves to be profitable. For instance, in the case of Internet income, some people may only earn a few dollars each month. In the case of property rental, the pay off is potentially great, since both the value of the real estate and a steady rental income belongs to the property owner, but poor management or a natural disaster could cause serious setbacks. Additionally, there are many scams promising huge amounts of residual income in return for upfront fees, so it's important to thoroughly research any ventures before putting money into them.

Taxes

Some forms of passive income are taxable, so it's essential to be aware of regional tax laws when collecting this type of income. In the US, the Internal Revenue Service (IRS) only considers two forms of income as passive: that from rentals, and that from indirectly participating in a business. Other types of residual income are considered either active income, or, in the case of investing, portfolio income. Some types of losses associated with residual income can be deducted from yearly taxes, but only up to the extent of the passive income, and it must be done in the year the income recipient gets rid of any interests in the income generating activity.

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Discussion Comments

By anon348521 — On Sep 17, 2013

The article has some very valid points.

When you are looking at internet options, for instance, I have personally been scammed more times than I can count.

When you are looking at things that require a lot of money up front, with the promise of a return, you can generally be concerned with the opportunity.

When you are building an online business of any type, you need to realize that there is some degree of effort in it, and that there is no way that anyone can guarantee an income of any sort.

One of the most important things in any business, whether online or not, is marketing. When you are trying to market, there are three things to consider.

First, find your target. Who are you trying to sell to?

Second, put a product out there that is of use to them.

Third, find out where those people will be.

Whether you are working to make a residual income or just a standard business, you need to consider those items.

This was something that I had pointed out to me by a woman who has made nearly a million dollars doing this.

By latte31 — On Aug 27, 2010

@Bhutan- That sounds like fun. You know my friend receives residual income online by writing articles.

She gets paid based on ad revenue and if she does not write another article she would still get paid. Many people in the creative field diversify this way because they feel that there are only so many hours in a day that you could write, and some day the income will be significant.

This is really passive residual income because it does not take any additional effort after a certain point. Some people chose to invest in businesses and may offer capital for the business in return for residual income.

You just have to make sure that the residual income offer is a legitimate residual income business opportunity that you will understand. Some people earn residual income in the hopes of using the income for retirement.

By Bhutan — On Aug 27, 2010

@Icecream17- I earn residual income from a rental property. It is a vacation property that I rent a few months out of the year during peak season. This is income that I get every year, but there is some effort on my part to make it happen.

By icecream17 — On Aug 27, 2010

Many people look to build residual income streams. Many earn residual income from investments. For example, bonds offer residual income.

Municipal bonds invest in a municipality and offer tax free payments between three to five percent of the initial investment.

If someone were investing one million dollars in municipal bonds, they could receive up to $50,000 tax free.

Some people invest in stocks that earn higher dividends for the same reason. On top of the regular earnings the dividends get reinvested and the principal grows. Upon retirement, if you have enough of a nest egg, you can live off the dividends and not touch the stock.

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