Open-Ended Leases: Everything You Need To Know
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Many potential car owners are apprehensive about leasing because they’re unclear about its benefits. After all, why should you lease a car when you can buy it and sell it afterward?
Depending on several factors like preferences and financial situation, leasing is a legitimate option to get you behind the wheel. True enough, the car leasing market continues to grow, and experts say it’s the future of car usership.
Having said that, many people aren’t aware that there are two types of car leasing: closed and open-ended.
If you’re considering leasing a vehicle soon, you’ve come to the right place. Today, we’ll discuss open-ended leases and the differences between an open and closed lease.
What is a Closed-End Lease?
To understand open-ended leases better, you must know how a closed-end lease works, aka the standard lease.
Also known as a “walk away lease” or “true lease,” a closed-end lease is an agreement that places no obligation to the lessee (the person borrowing the vehicle in exchange for periodic payments) to purchase the car at the end of the lease’s term.
Moreover, the terms in a closed-end lease are relatively strict, but the depreciation risk doesn’t fall on the shoulders of the customer - the risk falls onto the lessor. One of the most prominent stringent terms for a closed-end lease is payment for damages.
Basically, the lessee is responsible for paying for damages that go beyond normal wear and tear. Unfortunately, what constitutes “normal” wear-and-tear is generally more restrictive with a closed-end lease.
Closed-end leases also typically have mileage restrictions between 10,000 to 15,000 miles per year. Exceeding the mileage limits means paying a fee once the lease expires. If you exceed your limitations, it can be costly down the line.
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What is an Open-Ended Lease?
Also referred to as “finance leases,” an open-ended lease is a rental agreement where the lessee agrees to assume the depreciation risk of the vehicle’s value in return for better overall flexibility.
Essentially, the borrower is responsible for the vehicle’s residual value and must make a balloon payment at the end of the term based on the difference between the residual and fair market value (FMV) of the car. For example, if the residual value is about $15,000 and the FMV of the asset is only $13,000, the borrower will pay for the difference of $2,000.
Generally, there’s a pre-decided depreciation amount ahead of time, and both parties will agree to a minimum lease term - usually about 12 months. Still, it can vary from program to program.
Once the lease expires, the lessor will sell the vehicle if the renter doesn’t buy it. The lessee will receive the difference as reimbursement if the car is sold for more than the residual value. Think of it as an incentive for being a good steward of the vehicle.
On the other hand, if a genuinely hammered car sells for less than the residual value, the lessee shoulders the difference - this is what it means to assume the depreciation risk. Compare that arrangement with a closed-end lease where the renter gets to walk away after the lease expires.
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How It Works
To help you better understand open-ended leases, we’re inclined to provide an example to illustrate better how this type of lease works.
Let’s say your lease payments depend on the fact that a $15,000 brand-new vehicle will depreciate to $9,000 by the end of the term. Then, let’s assume that by the end of the term, the actual fair market value of the car is actually $7,000.
Since both parties (you and the lessor) have agreed to base the monthly payments on the vehicle’s pre-established $9,000 salvage worth, you must reimburse the lessor the $2,000 difference. This is with the assumption that you’re purchasing the car.
On the other hand, if you’re purchasing the vehicle, you’re essentially bearing the brunt of the loss due to depreciation. But if you’ve taken good care of the car or used it sparingly, and the value is worth more than $9,000, the lessor will give you a refund based on the difference.
Closed vs. Open-Ended Leases
Open-ended leasing is more commonly used for commercial purposes (such as transport and courier companies) since it offers more control and flexibility to the lessee. These companies would rather amortize the depreciation cost instead of paying costly penalties at the end of the lease.
Let’s say the company needs to downsize its fleet or it needs larger vehicles; they can outright terminate the lease - provided that the vehicle’s value matches the agreed-upon residual value. Since the renter assumes the depreciation risk, open-ended leases don’t have mileage limits or set terms. Also, an open-ended lease will prevent you from incurring exorbitant excess mileage fees if you’re clocking in huge miles on your vehicles.
However, it would help if you remembered that open-ended leasing isn’t generally open to consumers who won’t use the vehicles for non-commercial purposes. This is because businesses and companies can bear the depreciation risk at the end of the lease - for normal consumers, not so much.
As an individual consumer, you’re more likely to end up in a closed-end lease. This type of leasing makes more sense for the general consumer because of the predictable duration of the trips - usually from home to work and back. This results in consistent mileage, and the driver is unlikely to exceed the limit. Plus, normal wear and tear are in the hands of the driver.
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Which Type of Car Lease is Right for Me?
Unless you’re with a company that needs a fleet of vehicles for commercial intent, you should stick to closed-end leasing. The lessor may give you a choice between open and closed leasing, so make sure to confirm by checking the lease agreement.
Conversely, businesses and companies are better off with open-ended leases since they have the financial capability to absorb the high depreciation cost in exchange for benefits like unlimited mileage.
Frequently Asked Questions
Q: What happens after an open-ended lease?
An open-ended lease puts the responsibility of the residual value on the lessee. Thus, in that sense, there are no mileage limits. At the end of an open-ended lease, the borrower may purchase the vehicle based on the car’s residual value on the contract or return the vehicle and pay for the difference between the residual value and market value.
Q: Which type of lease is right for me: open-ended or closed?
In reality, most traditional leases acquired by consumers are closed-end leases. Closed leases offer predictability as to how much you’ll pay once the lease ends – provided you stick to the mileage limits and the vehicle remains in good condition. Open-ended leases are more suited to businesses that use multiple vehicles (i.e., fleets) and want more flexibility in terms of mileage and lease terms.
Q: Should I buy the car at the end of the lease?
While there’s a buyout option at the end of an auto lease, purchasing the vehicle is generally not a good idea. The simple reason is that with a lease buyout, your overall cost of financing is higher. You’re so much better off buying the car from the beginning.
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