Let’s quickly answer “what is a lease?“
A lease is a method by which an individual or company can obtain the use of a vehicle for a fixed period of time by making regular periodic payments (that are tax-deductible for business applications). The lessee is essentially paying for the depreciation they put on the vehicle during their lease. As lease payments aren’t covering the full value of the vehicle, but rather the depreciation accrued, leases don’t require a significant cash outlay and have lower monthly payments than if financing the entire purchase price inclusive of taxes.
What is a closed-ended lease?
The type of lease with which most consumers are familiar is known as a closed-ended lease. This is a retail lease offered by most manufacturers and dealerships on new vehicles. With a closed-ended lease, the lessee will lease the vehicle for a fixed term, with a fixed km or mileage allowance and restrictions on use with a subjective clause allowing for “reasonable” wear and tear. The monthly payment is derived from the difference between the MSRP or retail price and the pre-determined residual value established by the manufacturer. Closed-ended leases can work for many individuals and the occasional company, but the user needs to fit nicely within the confines of the established lease structure. If you do fit within this fixed structure, then a closed-ended lease can be a very good option for you – just don’t expect any flexibility or the ability to easily get out of your lease ahead of schedule without penalty, as you’ll be upside-down until the day your lease ends. There are resources like LeaseBusters.com to assist, but you’ll need patience and to provide a financial incentive for someone to take over your now-used vehicle at a new car monthly lease payment.
But the closed-ended lease isn’t the only type of lease. There’s another type of lease that’s been popular and common with businesses for quite some time and is been gaining traction with consumers: the open-ended lease.
What is an open-ended lease?
How does an open-ended lease differ from a close-ended lease? An open-ended lease isn’t available solely on new vehicles; pre-owned vehicles can be leased using an open-ended lease. Open-ended leases can be particularly attractive for higher-end luxury and sports cars, especially pre-owned ones. By allowing the original vehicle owner to “take the hit” of the steep depreciation from the first couple years of ownership, leasing a pre-owned vehicle that’s a couple of years old over three or four years can be a great way to own a premium car if you like flexibility and the ability to change vehicles every few years. If you like to buy cars cash and drive them into the ground, leasing won’t make sense for your ownership style. But if you like flexibility and value, an open-ended lease could do the trick.
It’s very important to ensure the structure of a lease is devised to protect you from being “upside down” throughout the course of your lease. To do this, the leasing company should ensure the established residual (which is up to the leasing company’s discretion) is realistic and conservative. This ensures that at the end of your lease you’re not having to cut a big cheque for the difference in value between the predicted residual and the actual term end value. By artificially inflating the residual, an unscrupulous leasing company could make the monthly payments lower and more attractive but leave you exposed to cover any shortfall in value at the end of your lease. This would create a structure similar to that of a “balloon payment” where a large lump sum is due when you hand over the keys. But a well structured open-ended lease will ensure the vehicle is being depreciated appropriately and you will be able to simply toss the leasing company the keys at the end of the lease – or even before – and not find yourself upside down. In fact, a conservative residual would actually mean you end up with positive equity as the value of the vehicle at the end of the lease is greater than the predicted residual and the leasing company cuts you a cheque! There’s no obligation to buy the car at the end of the lease, but you definitely have the option to do so at the residual price should you want to.
So the biggest benefits to an open-ended lease are the ability to: lease a pre-owned vehicle, build equity, step out of your lease early without penalty (provided the lease is well structured), and drive as much or as little as you like without confines or “reasonable wear and tear” restrictions. In simplest terms, you pay only for what you use. And for these reasons it’s easy to see why open-ended leases are gaining popularity.
If you’d like assistance developing a well-structured open-ended lease, I’m at your disposal.