There are two main types of car leases, known as “closed-end” and “open-end” leases.
Most consumer auto leases are closed-end, otherwise known as “walk away leases,” meaning you return your car at the end of the specified lease term with no further obligation, aside from perhaps mileage overage and any damage to the vehicle.
The beauty of a closed-end lease is that you don’t have to worry about the value of the vehicle once your lease comes to an end. If it’s worth less than what the financing company expected it to be, that’s their problem. At the same time, if the car is worth more, you’ll have the option of buying it, trading it in for a new car, or selling it privately to make a tidy profit.
The other main type of auto lease is an open-end lease, which is a lot more common in the commercial space than the consumer space. With this type of lease, you must pay the difference between the lease-end residual value of the vehicle and the actual market value, known as the “end-of-lease payment”. For this reason, the residual is typically set quite low to reduce the risk of paying out-of-pocket at the end of the lease. However, as a result, the monthly payments will be higher to compensate.
An open-end lease may make sense if you don’t want to purchase a vehicle outright, but you drive a considerable amount of miles each year. There aren’t any mileage constraints with an open-end lease, but as mentioned earlier, monthly payments could be higher and you may have to make up for the difference between the value of the car and the residual at the end of the lease term. Essentially, you take a gamble on the value of the car at lease-end.
Vehicle Value = $20,000
Expected Residual = $10,000
Actual Lease-end Value = $7,500
In the above example, the vehicle didn’t hold its expected value through the lease term, and actually fell short by $2,500. As a result, you would have to the pay the financing company $2,500 to make up the difference when returning the vehicle. Or just buy the car outright for $10,000.