Closed-End Lease

DEFINITION of 'Closed-End Lease'

A closed-end lease is a rental agreement that puts no obligation on the lessee (the person making periodic lease payments) to purchase the leased asset at the end of the agreement. Also called a "true lease", "walkaway lease" or "net lease."

BREAKING DOWN 'Closed-End Lease'

Since the lessee has no obligation to purchase the leased asset upon lease expiration, that person does not have to worry about whether the asset will depreciate more than expected throughout the course of the lease. Thus, it is argued that the closed-end leases are better for the average person.

For example, suppose your lease payments are based on the assumption that the $20,000 new car that you are leasing 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. But, if you have a closed-end lease, you do not have to buy the car so you do not bear the risk of depreciation.

How Closed-End Leases are Structured

Typically a closed-end lease comes with a fixed rate and a term that may run 12 to 48 months. The lessee might want to terminate the agreement early, a move that often incurs additional fees for the early exit. For vehicles procured through such an agreement, there are often annual mileage limits that tend to range from 12,000 miles to 15,000 miles. If use of the vehicle exceeds those limits, the lessee is then responsible to pay additional fees. Those fees can be based on a set cents-per-mile penalty over the limit. The fees may also be tiered or structured on a graduated scale where the lessee pays one lump charge that covers the first few hundred miles beyond the limit, then a cents-per-mile fee beyond that. Furthermore, the lessee is responsible for any excess wear and tear that occurs with the asset.

At the conclusion of a closed-end lease, the lessor might look to sell the asset at its depreciated value. It is possible that the lessee might still seek to purchase the asset at that this new rate, and there may even be incentives offered to complete such a deal at a reduced price compared with other potential buyers.