Definition
– Closed-end lease: a lease contract in which the renter (lessee) has no contractual obligation to buy the asset at lease end. The owner (lessor) takes the residual-value risk—the difference between expected and actual market value at lease termination.
– Lessee: the person or business making periodic lease payments.
– Lessor: the party that owns the asset and receives lease payments.
– Residual value: the projected market value of the leased asset at the end of the lease term.
How it differs from an open-end lease (short)
– Closed-end: lessee can “walk away” at lease end without making up any shortfall if the asset depreciates more than expected. Terms are usually tighter (mileage caps, wear standards).
– Open-end: lessee bears depreciation risk; if the asset is worth less than the estimated residual value at lease end, the lessee must pay the difference.
How closed-end leases are typically structured (step-by-step)
1. Capitalized cost: negotiated price of the asset (often close to sale price).
2. Residual value: set in the contract as the expected end-of-lease value.
3. Term: length of the lease (commonly 12–48 months).
4. Money factor: the lease’s finance charge expressed as a small decimal; converts roughly to APR by multiplying by 2,400.
5. Monthly payment: roughly the sum of the monthly depreciation charge plus the monthly finance charge (plus taxes/fees).
6. Usage limits and charges: annual mileage allowance (e.g., 12k–15k miles) and per-mile penalties for excess; standards for permissible wear and tear; early termination penalties.
Pros and cons (concise)
Pros
– No purchase obligation at end of term.
– Predictable monthly payments when contract terms are followed.
– Protection from greater-than-expected depreciation risk.
Cons
– Extra charges for excess miles and for abnormal wear and tear.
– Early termination usually carries significant fees.
– Some fee structures are tiered—initial miles over the limit may incur a lump charge, then per-mile fees beyond that.
Quick checklist before signing a closed-end lease
– Confirm the capitalized cost and any fees rolled into it.
– Check the residual value and how it affects monthly payments and buyout price.
– Note the money factor and convert it to an approximate APR (money factor × 2400 ≈ APR).
– Verify mileage allowance and per-mile penalty for excess miles.
– Ask about wear-and-tear standards and inspection process at lease end.
– Ask about early-termination fees and whether gap insurance is included or recommended.
– Compare total lease cost vs. buying (use an auto loan calculator to model purchase scenarios).
Small worked example (numeric)
Assumptions
– Vehicle price (capitalized cost): $20,000
– Contract residual value after 36 months: $10,000
– Term: 36 months
– Money factor: 0.002 (≈ 4.8% APR since 0.002 × 2400 = 4.8%)
– No taxes/other fees included in this simplified example
Calculations
– Total depreciation = $20,000 − $10,000 = $10,000
– Monthly depreciation = $10,000 ÷ 36 = $277.78
– Monthly finance charge ≈ (capitalized cost + residual) × money factor
= ($20,000 + $10,000) × 0.002 = $60
– Approximate monthly lease payment (before tax/fees) = $277.78 + $60 = $337.78 ≈ $338
Example of end-of-lease scenarios
– If actual market value at lease end is $4,000 (well below $10,000), with an open-end lease the lessee could be billed for the $6,000 shortfall. With a closed-end lease, the lessee walks away with no depreciation reimbursement.
– If market value is $14,000 at lease end, the lessee could buy the car for the $10,000 residual and immediately resell for $14,000, pocketing the difference (minus transaction costs).
Common fee examples (illustrative)
– Mileage overage: 3,000 extra miles × $0.25/mile = $750
– Early termination: varies widely; often several hundred to several thousand dollars depending on remaining payments and contract terms.
When a closed-end lease makes sense (general considerations)
– You prefer predictable monthly payments and don’t want end-of-term depreciation risk.
– You drive within the agreed mileage and maintain the asset according to the lease’s standards.
– You want lower monthly cash outflow relative to buying (but you won’t build ownership equity).
When to be cautious
– You expect high mileage or heavy use that will trigger excess charges.
– You plan to keep the asset long-term—buying may be cheaper over many years.
– You want maximum flexibility for modifications or early termination.
Sources for further reading
– Investopedia — Closed-End Lease: https://www.investopedia.com/terms/c/closed-endlease.asp
– Consumer Financial Protection Bureau (CFPB) — What to know about auto leases: https://www.consumerfinance.gov/consumer-tools/auto-loans/
– Edmunds — Guide to Leasing a Car: https://www.edmunds.com/car-leasing/how-leasing-works.html
– Kelley Blue Book (KBB) — Should I Lease or Buy?: https://www
https://www.kbb.com/car-advice/should-i-lease-or-buy/
Practical checklist before you sign a closed‑end lease
– Confirm the capitalized cost (cap cost). This is the negotiated price of the vehicle used to compute payments. Get it in writing.
– Confirm the residual value (expressed as a dollar amount or percentage) and the lease term (months). The residual is the expected end‑of‑lease value.
– Get the money factor and know how it converts to an APR (money factor = APR_decimal / 24). Ask for both numbers.
– Verify included mileage allowance and the excess‑mileage charge per mile.
– Ask about fees: acquisition fee, disposition fee, security deposit, documentation fee, and any upfront taxes.
– Check wear‑and‑tear standards and excess wear charges.
– Confirm who pays sales tax (upfront, monthly, or capitalized into the lease).
– Ask about gap insurance (covers the difference if the car is totaled and insurance payout is less than the lease balance).
– Understand early‑termination rules and buyout price if you decide to purchase the vehicle during or at the end of the lease.
– Get a signed copy of the lease contract and compare it to all verbal promises.
Worked numeric example (step‑by‑step)
Assumptions (example only):
– Manufacturer’s suggested retail price (MSRP): $30,000
– Negotiated cap cost: $28,000
– Lease term: 36 months
– Residual: 55% of MSRP → residual value = 0.55 × $30,000 = $16,500
– Money factor: corresponds to a 6.0% APR. Convert: APR_decimal = 0.06 → money factor = 0.06 / 24 = 0.0025
– Sales tax: 7% applied to monthly payment
Step 1 — Depreciation fee:
Depreciation = (Cap cost − Residual) / Term
= ($28,000 − $16,500) / 36
= $11,500 / 36 = $319.44
Step 2 — Finance (rent) charge:
Finance = (Cap cost + Residual) × Money factor
= ($28,000 + $16,500) × 0.0025
= $44,500 ×
× 0.0025 = $111.25
Step 3 — Base monthly payment (before tax)
– Depreciation fee + Finance charge = $319.44 + $111.25 = $430.69
Step 4 — Sales tax (7% applied to monthly payment)
– Tax = 0.07 × $430.69 = $30.15
– Total monthly payment = $430.69 + $30.15 = $460.84
Summary of totals (36‑month term)
– Total depreciation paid = $319.44 × 36 = $11,500 (this equals cap cost − residual)
– Total finance (rent) charges = $111.25 × 36 = $4,005
– Total base payments (before tax) = $11,500 + $4,005 = $15,505
– Total sales tax paid = $30.15 × 36 = $1,085.40
– Grand total paid over 36 months = $460.84 × 36 ≈ $16,590.35
– Residual at lease end (if you buy the car) = $16,500 (separate; not included in monthly total)
Optional: effect of a $2,000 cap‑cost reduction (down payment)
– New cap cost = $28,000 − $2,000 = $26,000
– Depreciation = ($26,000 − $16,500) / 36 = $9,500 / 36 = $263.89
– Finance = ($26,000 + $16,500) × 0.0025 = $42,500 × 0.0025 = $106.25
– Base monthly = $263.89 + $106.25 = $370.14
– Tax = 7% × $370.14 = $
– Tax = 7
% × $370.14 = $25.91 (rounded)
– Total monthly payment (with tax) = $370.14 + $25.91 = $396.05
– Sales tax paid via monthly payments = $25.91 × 36 = $932.76
– Grand total paid over 36 months (monthly payments only) = $396.05 × 36 = $14,257.80
– Add cap‑cost reduction (down payment) = $2,000 → Total cash outlay over lease term = $14,257.80 + $2,000 = $16,257.80
– Residual if you buy at lease end = $16,500 (separate; not included in totals above)
Assumptions and notes
– Money factor used: 0.0025. Finance charge formula: (Adjusted cap cost + Residual) × Money factor = monthly finance charge.
– Depreciation formula: (Adjusted cap cost − Residual) / Lease term = monthly depreciation.
– Sales tax assumed charged monthly on the lease payment only (some states tax cap‑cost reductions or tax the full sale price up front; check local rules). If your state taxes the down payment up front, add applicable tax on $2,000.
– Rounding: monthly figures rounded to cents; small rounding differences may change totals by a few dollars.
Quick checklist to replicate this calculation for any lease
1. Determine: negotiated cap cost, residual value, lease term (months), money factor, local sales tax rate, and any cap‑cost reduction (down payment).
2. Compute adjusted cap cost = negotiated cap cost − incentives/down payment.
3. Compute monthly depreciation = (Adjusted cap cost − Residual) / Term.
4. Compute monthly finance = (Adjusted cap cost + Residual) × Money factor.
5. Base monthly = depreciation + finance.
6. Monthly tax = sales tax rate × base monthly (or follow your state’s tax rule).
7. Monthly payment = base monthly + monthly tax.
8. Total payments = monthly payment × Term + any up‑front payments (down payment, fees). Compare this total to buying costs (loan payments + taxes + depreciation) for a full cost comparison.
Worked numeric summary (this example)
– Adjusted cap cost = $26,000
– Residual = $16,500
– Term = 36 months
– Money factor = 0.0025
– Sales tax = 7%
– Monthly depreciation = $263.89
– Monthly finance = $106.25
– Base monthly = $370.14
– Monthly tax = $25.91
– Monthly payment = $396.05
– Total paid over 36 months (including $2,000 down payment) = $16,257.80
– Residual purchase option at lease end = $16,500 (additional if you choose to buy)
Educational disclaimer
This is educational information, not individualized investment or legal advice. Lease terms, taxes, and fees vary by state and dealer; verify numbers and tax rules before signing a contract.
Sources
– Investopedia — Closed‑End Lease overview: https://www.investopedia.com/terms/c/closed-endlease.asp
– Consumer Financial Protection Bureau — Guide to Auto Loans and Leasing: https://www.consumerfinance.gov/consumer-tools/auto-loans/
– Edmunds — How Car Leasing Works: https://www.edmunds.com/calculators/how-leasing-works.html