What are car leases?

Car lease sign
Leases are an alternative route to taking out an auto loan and purchasing a vehicle. When consumers lease a vehicle, they essentially rent a car, as they pay a monthly bill in order to keep it. There are two primary types of car leases: open-end and closed-end. While they both operate much in the same way, closed-end agreements are what most consumers are familiar with. These allow consumers to “walk away” from the car lease when the term has expired, whereas open-ended agreements often require consumers to pay a fee the term has lapsed.

Closed-End Car Leases

Closed-end car leases, often called “walk away leases,” are what most everyday consumers agree to when they lease a vehicle.

Dealerships lease automobiles under the assumption that a consumer will not exceed a certain mileage threshold. A 10,000 to 15,000 mile limitation is a typical range, but that mileage can fluctuate depending on the individual consumer and lender making a deal. Additionally, consumers are expected to take care of the vehicle and return it at the end of the term.

All leased cars are assigned a “residual value” at the time of leasing, which is the dealer’s predicted value of the vehicle after the agreement’s term expires.

When a vehicle is returned, the consumer often has the option—but not the obligation—to purchase the vehicle for its current appraised value. If the appraised value is higher than the residual value, then prudent consumers can take out an auto loan and purchase the vehicle, acquiring an asset that can be easily sold for a profit. If the appraised value is lower than the residual value, then the consumer knows this vehicle’s value is declining faster than it should, allowing the consumer to walk away completely free of the financial obligation.

Open-End Car Leases

Open-end leases, on the other hand, are more restrictive than their closed-end counterparts. These require consumers to pay a fee when the lease term expires if the vehicle’s value has depreciated. Due to this, open-end car leases are usually reserved for large businesses looking to provide employees with company vehicles.

Additionally, since open-end leases tend to be for commercial use and since there’s a risk of paying a fee come the expiration of the term, their annual mileage limits tend to be much greater than closed-end agreements.

When the term does expire, the vehicle is appraised, and if the new value is less than the residual value, the company or consumer is forced to pay the difference.

The Cons of Leasing a Vehicle

When considering an auto loan or a lease, there are a few things to keep in mind.

One key difference between ownership and leasing is the ability for consumers to treat the vehicle in whatever manner they wish. Leasing requires a consumer to return the vehicle in the same state it was received, with the only difference being what the vehicle undergoes as a result of “normal” wear and tear. Those who own a vehicle, however, can modify and drive it as they wish.

But perhaps the most important difference is that auto loans allow consumers to work towards ownership and the building of equity. Leases, on the other hand, do not. Money put towards a lease agreement is given away in exchange for essentially renting an asset. No equity is built, and consumers won’t have a vehicle to liquidate later in order to see a return of some of that money.