Auto Leases

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By: Financial Hotline
Fall 2018 (Vol. 36, No. 3)

Q: How does an auto lease work?

A: There are two types of lease arrangements: closed-end (“walk-away”) and open-end (finance). Here’s how they work:

Closed-End

The Dealer Bears the Risk of Depreciated Value

When a closed-end lease is up, you bring the car back to the dealership and “walk away.” You must return the car with only normal wear and tear and with less than the mileage limit specifi ed in your lease. Since the dealer is bearing the risk that the value of the car at the end of the lease will go down, your monthly payment is higher than with an openend lease.

Open-End

You Bear the Risk of Depreciated Value

With the open-end lease the customer bears the risk that the car will have a certain value (called the “estimated residual value”) at the end of the lease. The monthly payment is lower because of this risk. When you return the car at the end of the lease, the dealer will have the car appraised. If the car’s appraised value is at least equal to the estimated residual value in the agreement, you won’t need to pay anything at the end of the lease term. Under some contracts, you can even receive a refund if the appraised value is higher than the residual value stated in the contract. If the appraised value is lower than the residual value, however, you may have to pay all or part of the difference.