The difference between a closed-end car lease and an open-end car lease comes down to who bears ultimate financial responsibility for the decline in value of the leased automobile. In a closed-end lease, the responsibility remains with the dealer. In an open-end lease, the person who leases the vehicle assumes the responsibility.
Function
In a typical auto lease, you sign a lease agreement and drive away in a new car. You drive the car for the length of the lease term, paying a monthly fee for the privilege of doing so. That fee is based in part on how much the car can be expected to depreciate -- that is, how much of its value will be lost -- during the lease. After all, a 3-year-old car is worth substantially less than a brand-new one, no matter how well it has been cared for. The expected value at the end of the lease is called the "residual value," and it's determined at the inception of the lease. The lower the residual value relative to the original price of the car, the higher your monthly payments will be. At the end of the lease, you have the option of buying the car for the residual value or returning it to the dealer.
Significance
When the lease ends, there's a chance that the car's actual market value will be less than the expected residual value. This could be because you drove it more than you expected it to, or just because there's no demand for 3-year-old versions of that particular model. Regardless, someone is going to have to "eat" the cost difference between the actual value and the residual value.
Types
In a closed-end lease, if you don't want to buy the car, you simply drop it off. The dealer -- actually, the leasing company that handles the transaction on behalf of the dealer -- has to absorb the difference between actual and residual value. That's why closed-end leases are commonly called "walk-away leases." Lease agreements generally have mileage limits, so you may have to pay a fee for each mile you went over, and you'll also have to pay for any damage. But you're not responsible for the difference if the car ends up worth less than the residual value.
In an open-end lease, the risk lies with you. If the car's market value is worth less than the pre-determined residual value at the end of the lease, then you must pay the leasing company the difference.
Benefits
Closed-end leases make the most sense for consumers. Not only do they gain protection from having to pay for low market value, most consumers also have relatively predictable driving patterns that allow them to stay under the mileage limits, meaning their out-of-pocket costs at lease end are minimal. Open-end leases make sense mostly for commercial businesses. Not only are their driving needs more variable, but any extra costs can be written off as a business expense.
Consideration
According to the Federal Reserve Board, the "three-payment rule" may limit the amount of money you have to pay at the end of an open-end lease. Under this rule, the car's pre-determined residual value is assumed to be "unreasonable" if it exceeds the market value by more than three times the amount of the monthly payment. So if your monthly payment is $450, the leasing company cannot require you to pay more than $1,350 for a deficiency between market value and residual value, unless it can demonstrate in court that the residual value was in fact reasonable.
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