What Is Residual Income & How Do You Build It? | Capital One (2024)

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.

Key takeaways

• 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.

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.

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

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 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.