Open- vs. closed-end leases: What you should know

Man smiling at a car dealership, somebody is handing over car keys to himImage: Man smiling at a car dealership, somebody is handing over car keys to him

In a Nutshell

When you lease a car, you’ll usually be offered a closed-end lease. In a closed-end lease, the leasing company takes on the risk of any additional depreciation. In an open-end lease — more common in business leasing — the person or company leasing the vehicle takes on that risk, but leasing terms may be more flexible.
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When leasing a car, you may have the option of an open-end or closed-end lease.

With both types of leases, the car’s estimated value at the end of the lease term — known as the residual value — serves as the basis for calculating your monthly payment. But there can be a major difference between how much you owe at the end of each type of lease.

Let’s take a deeper look at how open- and closed-end leases work and which might be best for you.

How a closed-end lease works

With a closed-end lease, also known as a walkaway lease, you typically have a set lease term and mileage limits. You’re responsible for the vehicle’s condition, but the leasing company is responsible for any additional depreciation to the vehicle below the residual value at the end of the lease.

When you take out the lease, the leasing company determines the residual value for the vehicle. This value is the anticipated value of the car when your lease term is up, and is used to determine your monthly lease payment. The car’s expected depreciation, along with the rent charge (cost of financing), sales taxes and fees, make up your monthly payments.

At the end of the lease, if you’ve exceeded the mileage limits or if the car has a lot of wear and tear, you’ll typically pay fees to help reimburse the leasing company for the resulting excess depreciation. But you aren’t financially responsible for additional depreciation below the residual value.

If the car depreciates less than originally expected, the leasing company benefits — and you might be able to as well. If your lease has the option to purchase the car is and it’s worth more than the purchase-option price, buying out the lease may be a worthwhile investment.

How an open-end lease works

An open-end lease can have flexible mileage limits or set lease terms, but that flexibility comes at a cost. You, rather than the leasing company, are responsible for the difference between the car’s residual value and its actual value.

If you put a lot of miles on the odometer or cause some damage, the value of the vehicle may end up lower at the end of the lease than originally anticipated. In this case, you’d need to make up the difference between the actual value of the car and the residual value stated in the lease.

On the other hand, you may get a refund if the car’s value is higher than the residual value at lease end.

Let’s say you lease a car with a residual value of $12,000 stated in the lease contract. When the open-end lease is over, you decide to turn in the car, which is worth $11,000. In this case, you’d likely be responsible for paying the $1,000 of depreciation in excess of the $12,000 residual value stated in the lease.

Which type of lease should I get?

While you may have a choice between an open-end and closed-end lease, most consumer leases are closed-end leases. When considering a lease, check the lease documents to see if the lease you’re being offered is an open- or closed-end lease.

Closed-end leases can provide some predictability regarding how much you’ll pay to use the car over the term of the lease, assuming you stick to the mileage limit and the car remains in good condition.

Open-end leases are more common in the business world. Businesses with fleets that tend to rack up a lot of miles or that want more flexibility in their lease terms may find open-end leases attractive.

Bottom line

While it’s possible you’ll get to choose an open-end or closed-end lease, for consumers, chances are good that your car lease will be closed-end. Be sure to confirm by checking your lease agreement or asking your leasing company.

To help avoid any mileage fees at the end of a closed-end lease, be sure the mileage limit stated in your lease agreement lines up with your lifestyle. If it doesn’t, you could try negotiating for extra miles. Those extra miles may result in a higher monthly payment, but the cost still might be less than the fee you could have to pay at lease end if you exceed your mileage.

You can also help avoid excess wear and tear charges by keeping your car in good shape, and that typically means keeping up with maintenance. Some leasing companies may even charge you when your lease is up if you don’t get the required maintenance on your car.

About the author: Lance Cothern is a freelance writer specializing in personal finance. His work has appeared on Business Insider, USA and his website, Lance holds a Bachelor of Business Administration in … Read more.