Effective Gross Income - EGI

You inherit a haunted house from a long-lost uncle you didn't know you had. You decide to rent it out to earn a little cash. Other similar homes in that area are renting for $2,500 a month. So that means your annual income from the property will be $30,000, right? After all, that's $2,500 a month times 12 months in a year...gives you $30,000 a year.

Kind of. That figure is called your gross potential income. It's the hypothetical total you'd receive if everything goes perfectly. But everything rarely goes perfectly. Thus, effective gross income becomes a more realistic figure.

You can start with gross potential income, but the "effective" part becomes key in a real-life scenario. There are other factors to take into account.

Some of these are good. A property can generate other income besides rent. Your uncle's house has a coin-operated washing machine in the basement and pay toilets in all the bathrooms. Extra money for you. Those figures get added in when you calculate the effective gross income.

However, some factors take away from the final total. For instance, you might have a hard time finding a tenant. It's a haunted house, after all (and one with pay toilets). Having the house vacant while you look for a renter will take away from your income.

Similarly, you have to take into account the fact that some renters don't always pay on time, or at all. If they don't, that cuts into your income as well.

Effective gross income takes this into account. Start with your gross income, add in the additional income, and subtract for the vacancy and credit allowances. It gives you a more realistic figure about what to expect in terms of annual income.