What is an Open-End Lease?
An open-end lease is a type of rental agreement that obliges the lessee (the person making periodic lease payments) to make a balloon payment at the end of the lease agreement amounting to the difference between the residual and fair market value of the asset. Open-end leases are also called "finance leases."
Often open-end leases are used in commercial transactions. For example, when a moving business procures a fleet of vans and trucks, an open-end lease may prove to be a better bargain due to the unlimited mileage offered under the terms of a lease.
- Open-end leases are used for both commercial and individual purposes—often for purchasing or leasing vehicles.
- An open-end lease for apartment or home rentals may be based on a month-by-month rental agreement between the landlord and the renter.
- In terms of flexibility, the open-end lease is typically less rigid than a closed-end lease.
How an Open-End Lease Works
Since the lessee must purchase the leased asset upon lease expiration, that person bears the risk that the asset depreciates more than was expected by the end of the lease. Of course, at the same time, the lessee stands to realize a gain if the asset depreciates less than expected.
There are different opinions on whether an open-end lease is more appropriate for an enterprise that intends to own the vehicle at the end of the term.
For example, suppose your lease payments for a car are based on the assumption that a $20,000 new car will be worth only $10,000 at the end of your lease agreement. If the car turns out to be worth only $4,000, you must compensate the lessor (the company who leased the car to you) for the lost $6,000 since your lease payment was calculated on the basis of the car having a salvage value of $10,000. Basically, since you are buying the car, you must bear the loss of that extra depreciation. Conversely, if the car is worth more than $10,000 at the end of the lease, you receive a refund from the lessor.
Open-End vs. Closed-End Leases
In the case of vehicles procured through an open-end lease, typically there is no restriction on the mileage that can be accumulated during the terms of the agreement. This allows the operator to use the vehicle as they see fit, with the understanding that they will purchase the vehicle in the condition they have put it in.
A closed-end lease, by some accounts, may make more sense for a general consumer who needs a vehicle that will make somewhat regular trips, usually to work and home, of predictable length, meaning the mileage should be consistent and the wear and tear will be regulated.
An open-end lease can make more sense for an enterprise because the company might be able to select the depreciation rate of the asset at the time of the signing, allowing for more control of how the costs for agreement play out. Furthermore, an open-end lease can inform the lessee about the financial stability of the company leasing out the asset, by gauging rates they make available to their customers.