Residual income is the amount of personal income left after an individual has paid his bills and periodic mortgage payment (expressed on a monthly basis). Residual income is an important consideration for a lender; if a loan applicant shows a large amount of residual income remaining each month, this means the person's current income level is more likely to support the payments associated with an additional loan. Conversely, a minimal amount of residual income is likely to trigger an immediate rejection of a loan application. Residual income tends to increase dramatically later in life, after a person's mortgage has been paid off.
A different definition of residual income is that this is income derived from passive investments, rather than from a person's active income-generating activities. Examples are interest income, royalty income, rent, and increases in the value of investments held. Individuals typically work throughout their careers in order to build up a sufficient amount of this income to support them during their retirement.
Yet a third definition of residual income relates to a business. It is the difference between the amount of operating income earned and the cost of the capital associated with those earnings. The formula is:
Residual income = Operating assets x Cost of capital
If an entity can generate profits with minimal assets, it will yield a larger amount of residual income than a business that must invest in a massive amount of assets to support operations.