Part 3: Types of Leases There are two basic types of leases
While leases come in a variety of shapes
and flavors, there are two basic types of leases, closed-end and
open-end. There's a major difference between the two types and
you need to understand this difference before entering into a
Closed-End Lease - In a closed-end lease, the residual is
set in advance and is guaranteed by the lessor. At the end of
the lease, the lessee has the right to simply return the vehicle to
the lessor and "walk-away."
The majority of consumer leases are closed-end leases.
Prior to signing a closed-end lease, the lessor estimates
the value of the vehicle at the end of the lease-term, and
sets the residual value. The lessee can either turn-in
the vehicle at the end of the lease, or purchase the vehicle
for the residual amount.
If the actual value of the vehicle at the end of the
lease period is less than the residual, the consumer just
turns in the keys and the lessor eats the loss on the
vehicle. If the value of the vehicle at the end
of the lease is greater than the residual, then you can
still purchase the vehicle for the residual amount.
You can then either keep the vehicle or sell it and keep the
profit. Being able to participate in any upside, while
being protected from any downside is a major advantage of
leasing. We discuss this topic in detail in the
Leasing as a Hedging Strategy section of our website.
Open-End Lease - In the open-end lease, the
lessee, not the lessor takes all of the financial risks at
the end of the lease. At the end of the lease, the
lessee can either purchase the vehicle for the amount of the
residual, or can return the vehicle and pay any difference
between the actual value of the vehicle and the residual.
The majority of open-end leases are commercial leases.
Annual mileage on a business lease is often-times greater
than the mileage on personal automobiles, and the
wear-and-tear can be significantly higher. Thus, the
actual value at the end of the lease period is harder to
estimate, and the lessor is unwillingly to underwrite this
Open-end leases typically have a lower residual than
closed-end leases, trading off higher payments for less risk
of a significant loss at the end of the lease-term.
Businesses use open-end leases to gain the financial and tax
advantages of leasing. In most cases, open-end leases
are not appropriate for consumers.