What the difference is between an open and closed end lease?
Open end versus closed end summary:
A closed end lease provides the lowest level of risk as long as you maintain the car or truck in good condition and don’t exceed the mileage limits. You’ll pay a higher lease payment, but you can walk away at the end of the lease without paying any surcharges. You can buy the car at the end of a closed end lease for the exact amount stated in the lease, but you’ll be paying retail price for the car. That locked in price may be more or less than the same car is selling for at used car lots in your area.
An open end lease is a bit riskier because it’s based on the car’s actual selling price at auction at the end of the lease. You often pay a lower monthly premium for an open end lease but may have to pay the difference between estimated residual value and actual selling price at the end of the lease. On the other hand, if the car sells for more than the estimated residual value at the end of the lease, you’ll get a refund. If you want to buy the car at the end of the lease, you can buy it for the wholesale auction price.
Open end versus closed end lease—the details
All leasing companies have to figure out what the leased vehicle will be worth at the end of the lease. That value is called residual value. During the course of the lease you’ll pay the difference between the new cost of the vehicle and its residual value.
Most leasing companies get the residual value from industry guides like the Automotive Lease Guide (ALG). However, the values listed in the guide are just a best guess based on that vehicle’s past selling history. If you’re leasing a brand new model, the ALG can’t possibly predict what the vehicle will be worth several years from now. If gas prices are high at the end of the lease, the residual value will drop for gas guzzler vehicles and rise for hybrid or high mileage vehicles. Since no leasing company can possibly know what the economy, used car market conditions or gas prices will be at the end of the lease, they often purposely reduce the guide’s residual value by a certain percentage.
What is a closed end lease?
On a closed end lease, the leasing company calculates a conservative residual value based on the lowest possible level of risk to the leasing company. At the end of the lease, you return the car and walk away. If the car sells for more than the stated residual value at auction, the leasing company makes money. If it sells for less, the leasing company loses money. Guess how often the leasing company loses money? Rarely. So closed end leases are usually based on lower residual values, which means you pay higher lease payments just to avoid end-of-lease risk.
Many closed end leases allow you to buy the car at the end of the lease, but the buy-out price isn’t based on wholesale auction price, it’s a retail price.
What is an open end lease?
An open end lease still uses an estimated residual value to calculate depreciation. But you don’t just turn in the car and walk away at the end of an open end lease. After turning in the vehicle, the leasing company sells the car at auction. Based on its actual selling price, you may owe more money or get a refund. In other words, when you lease a car with an open end lease, YOU assume the risk of what the actual residual value is at the end.
If you’re leasing a reliable vehicle that gets good MPG and take good care of your car, an open end lease may be a good option, especially if you want to buy the vehicle at wholesale cost at the end of the lease.
Many people prefer an open end lease just so they can buy the car at wholesale at the end. Then they immediately sell the vehicle and make money.
Closed end lease pros and cons
• you hate risk and have no room in your budget for a surprise payment at the end of the lease
• you’re leasing a new model with unknown reliability
• economic conditions are uncertain
• you want to walk away at the end of the lease
• if you go over the mileage limit you’ll pay a hefty end-of-lease fee
• if you don’t take care of your car you’ll pay a wear and tear surcharge
• you’ll pay more to avoid the end-of-lease risk
Open end lease pros and cons
• you’re leasing a proven reliable car that’ll have high demand at the end of the lease
• you take good care of your car and know it’ll be in good condition at the end of the lease
• you have confidence that the used cars will be in demand at the end of the lease
• you have the funds to pay the difference between estimated residual value and actual auction sell price.
• you don’t have to worry about a mileage penalty if you go over the estimated amount
• If gas prices spike or the economy tanks near the end of the lease and you’ve rented a gas guzzler, demand and residual value will plummet and you’ll have to pay
• If gas prices plummet and you lease a hybrid or high mileage vehicle, residual values may fall you you’ll have to pay
• If your car model develops a bad reputation for a serious defect like early transmission failure or engine problems, its residual value will fall and you’ll have to pay.
• It’s risky
©, 2016 Rick MuscoplatPosted on by Rick Muscoplat