What Is Residual Income? - Definition, Model & Formula

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  • 0:02 What is residual income?
  • 1:30 How is residual income…
  • 3:39 Lesson Summary
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Lesson Transcript
Instructor: Tara Schofield
Residual income is a highly attractive way to earn money. This lesson discusses two definitions of residual income and gives many examples of how residual income is earned.

What is Residual Income?

Residual income can have two different definitions or applications. The first definition, a less common application of residual income, is the money that is left after monthly debts are paid. This calculation is particularly important when a person is seeking financing or a loan based on their income and available money to cover the additional debt. In this scenario, the residual income is calculated by this formula:

Residual Income =Monthly Net Income - Monthly Debts

This calculation takes into account a person's take-home pay and subtracts debts and expenses from that amount. The remaining amount is the residual pay. The remaining money can be used for any other expenses.

The second way that residual income is defined is money that is earned on a continual basis that is often based from one original activity. Often this type of residual income is referred to as passive income. Earning residual income is a critical aspect of compensation for many salespeople, artists, and musicians.

Some perfect examples of residual income include:

  • Rental income from a home, apartment, or commercial space
  • Royalties earned for creating intellectual property like books, recordings, music, photographs, movies, television shows, etc.
  • Subscription services including media, online, or ongoing services
  • Interest earned on savings or loans made to others
  • Ongoing income such as retirement, alimony, disability, etc.

How is Residual Income Relevant?

The first form of residual income, the leftover cash after bills and expenses are paid, is important when a person is growing their savings account or is seeking a loan or financing. When getting a loan, there must be an adequate amount of residual income available to ensure a person has the money to make the loan payments each month. If there is not adequate residual income, financing or loans will not likely be approved.

The second form of residual income, passive income, is often a vital part of wealth creation. There are only so many hours in each day, and when a person trades hours for dollars, there is a maximum amount of income that person can earn. For instance, if a person earns a specific amount each hour, there is a limit to how many hours are available to work. Once they reach that maximum amount of time, they cannot earn more money.

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