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.
