Passive income is money that is earned from an enterprise that has little or no ongoing effort involved. Residual income is not actually a type of income, but rather a calculation that determines how much discretionary money an individual has available to spend after most monthly bills are paid.
One example of passive income is the profit realized from a rental property that is owned by investors who are not actively involved in managing the property. Another example is a dividend-producing stock that pays an annual percentage. While an investor must purchase the stock to realize the passive income, no other effort is required.
Residual income is a number that banks often calculate when determining whether applicants can afford a mortgage. To calculate residual income, the bank determines the applicant's income, and then subtracts the anticipated mortgage, property insurance and taxes. Any monthly payments made to credit cards, installment accounts or student loans also are subtracted from income. Food and utility expenses are not included in the calculation. The amount that is left after the subtractions are performed is considered residual income.
Banks compare an applicant's residual income to the cost of living in a particular area to determine if the individual's budget is too tight to handle a mortgage. For instance, an applicant who lives in the South and has a family of four must have a residual income of at least $1,003 a month if he wishes to take out a loan backed by the Veteran's Administration.