Open Ended Lease
A leasing arrangement that allows for an extra payment at the lease's end to account for any property value changes. A finance lease is another name for an open-end lease.
How an Open-ended Lease Works
An open-end lease is a form of rental agreement in which the lessee (you who is making monthly lease payments) will pay a balloon payment when the lease agreement ends. The balloon payment (referred to this as the Guaranteed Residual Value (GRV) in the lease contract) is equal to the difference between the asset's residual and fair market value. A finance lease is an alternative name for an open-ended lease.
In commercial transactions, open-end leases are common. For example, if you own a moving company and your company purchases a fleet of vans and trucks, an open-end lease can prove to be a better deal due to your unlimited mileage provisions. Since you (the lessee) are required to buy the leased asset at the end of the contract, you'll assume the possibility that the asset will depreciate more than expected by the expiration of the lease. At the same time, if the asset depreciates more slowly than you predicted, you will benefit.
At the end of the lease, you have the option of buying, selling, or trading in the leased vehicle for the GRV if the vehicle is worth at least that amount.
Example of an Open-Ended Lease
For better understanding, let's assume that your car lease payments rely on the fact that a $20,000 new car would only be worth $10,000 at the expiration of your lease agreement. Since you and the lessor determined your lease payment based on the car having a salvage worth of $10,000, you must reimburse the lessor (the company that leased the car to you) for the $6,000 lost if the car turns out to be worth just $4,000.
Essentially, since you are purchasing the vehicle, you must bear the loss of the additional depreciation. If the car is worth over $10,000 at the end of the contract, the lessor will give you a refund.
This assumes you're leasing a car with a $12,000 residual value listed in the lease contract. You intend to return the vehicle worth $11,000 at the end of the open-end contract. In this scenario, you'd most likely be liable for the $1,000 depreciation over the lease's stated residual value of $12,000.
Open-Ended Lease vs. Close-Ended Lease
In the case of vehicles you obtain by an open-ended contract, the mileage that you can accrue throughout the agreement is normally unrestricted. This gives you (the operator) the freedom to use the vehicle as you see fit, with the assurance that you would buy it in the same condition as you found it.
According to some accounts, a close-ended lease can make more sense if you're a general buyer who wants a vehicle that will make relatively frequent trips, usually to your work and home, of predictable duration. This implies that mileage is constant, and you control the wear and tear.
An open-ended lease can work better for a business because it allows the company to choose the asset's depreciation rate when signing, giving it more flexibility about the deal's costs. Furthermore, by gauging the rates available to their clients, an open-end lease will notify the lessee about the financial health of the business leasing out the asset.