Residual income: What it is and how to build it
August 9, 2022 4 min read
Understanding residual income, sometimes called discretionary or disposable income, can help you manage your cash flow. And you can use this leftover income to invest, save, pay off debt or splurge on things like a vacation. Building residual income can give you peace of mind about your finances.
- Residual income is your monthly income minus your monthly debts, like mortgage payments and credit card bills.
- Residual income can boost your finances and help you pay off debt faster, set aside money for retirement and build up your savings.
- Increasing your residual income can involve everything from taking on a side hustle to earning cash back from credit cards.
What is residual income?
Think of residual income like you’d think of Thanksgiving leftovers. Residual income refers to the money you have after you’ve taken care of ongoing expenses like your mortgage, credit card bills, utilities, groceries and car payments. This extra money can go toward things like investments, debt payoffs, savings or even a vacation fund.
You might have seen the term “passive income” used interchangeably with “residual income.” But this article will use these two terms differently. Passive income is income that you earn from little or no effort. And it can include rental property profits, dividend stocks or other sources.
You could use passive income streams to increase your monthly residual income. But residual income may not always come from passive income sources.
How to calculate residual income
You don’t need to be a math whiz to calculate residual income. In fact, the formula for residual income is simple: Just subtract your monthly expenses, like your mortgage, car payments and student loans, from your monthly income.
Here’s an example of how to find your residual income:
- Monthly gross income (before taxes): $5,000
- Monthly federal and state payroll taxes: -$750
- Monthly payments: Mortgage, credit card, student loan: -$1,900
- Monthly utility bills: -$200
- Monthly groceries: -$400
- Monthly residual income: $1,750
Why is residual income important?
Residual income is important for several reasons. For instance, lenders may consider your residual income when you apply for a loan. That’s because lenders want to see whether you have enough income to cover your current expenses and take on additional loan payments.
Here are some other reasons why residual income is important:
- Student loan providers can use your residual income to determine whether you qualify for an income-driven repayment plan.
- You can use residual income to boost your retirement savings.
- You could use residual income to build up an emergency fund.
- Residual income can go toward paying down debt.
- You can set aside residual income for nice-to-haves such as a new car, a vacation or a second home.
Residual vs. active vs. passive income
Residual, active and passive income are different types of incomes. Here are some key differences and examples of each kind.
Residual income vs. active income
Residual income is the amount of money you have after you’ve paid monthly bills like rent, car payments and utilities. On the other hand, active income is the money you earn from your job, business, side gig, freelancing career or some other type of work.
Residual income vs. passive income
Residual income is what remains from your monthly income after you’ve paid for monthly necessities like rent, student loan payments and utility bills.
But passive income is money you earn that requires little to no effort on your part. Examples of passive income can include:
- Returns on your investments, such as stocks and bonds.
- Rental property earnings.
- Royalties from a book you’ve written.
Passive income can contribute to residual income. For instance, dividends earned from stocks are passive income that can increase your total residual income.
But passive income isn’t necessarily residual income. And that’s because the amount of passive income you earn from book sales may be outweighed by the expenses associated with publishing and marketing that book. In this case, you’d have no residual income from the passive income generated by book sales.
How to build your residual income
There are many ways to build residual income. The key is to create more income than you spend. Here are seven residual income ideas to consider.
Increasing your income
One of the most straightforward ways to build your residual income is to increase the income from your full-time work. You could ask your boss for a raise. Or you may be able to increase your salary by changing jobs.
Taking on a side hustle
Are you a talented web designer? Are you interested in driving for a ride-share company? If you’re able to take on a part-time side hustle, these extra earnings could increase your residual income.
Reducing your monthly expenses can free up money to create residual income. For instance, if you pay off your credit card debt, your residual income could ultimately increase. But only if you don’t increase spending in other areas.
Renting out property
You can generate passive income from renting out your property for long-term or short-term leases. And the passive income you generate from rental property could increase your residual income. If you own your property outright, renting it out can be even more profitable.
Becoming a short-term host
Do you have a spare bedroom at your house? If so, you could look into short-term rental options. Some states and HOAs have restrictions on short-term rentals. If you’re interested in becoming a short-term rental host, it’s a good idea to research your state and neighborhood regulations first.
Investments like stocks and bonds can gain value over time. And some investments produce regular dividends. These earnings from investments could increase your residual income.
Reselling unused items
Do you need to clean out your closet? Have some electronic devices that you rarely use? You can create residual income by selling unused items through online and app-based marketplaces.
Earning credit card rewards
Many credit cards offer rewards in the form of cash back, points or miles. For instance, you might be able to collect 3% in cash back every time you use a certain credit card to fill up your gas tank. Credit card rewards could help you reduce expenses or increase your cash flow. And this can give you residual income to use elsewhere.
Residual income in a nutshell
Residual income can increase your cash flow and support financial security. If you’ve got residual income, it means you’re bringing in more money than you’re spending. And this extra money can help you achieve financial goals like paying off debt or saving for retirement. You can check out a few money management tips that could help you set yourself up for long-term success.