Definition of "Closed-end lease"
The definition of a closed-end lease is what happens when an individual rents or leases an asset at a monthly rate with no obligations for the lessee to purchase the asset that he rents at the end of the closed-end lease agreement. The closed-end lease definition involves the lessee - the individual taking out the lease - and a lessor - the institution giving out the lease. A rental agreement named a closed-end lease connects the two entities. The closed-end lease is also referred to as a “walkable lease”, “true lease” or “net lease”.
What does Closed-End Lease mean?
A closed-end lease involves monthly payments over a given period. There is no charge when the lease expires unless the lessee terminates the lease ahead of time or if the terms of the lease are not respected. At the expiration date, the lessor can sell the leased property for a gain or loss or lease it to someone else, and the lessee can buy that property or not. The lessee is not contractually obligated to purchase the asset if they don’t want to. The most common use for a closed-end lease is personal vehicle leases for individuals.
How does a Closed-End Lease work?
A closed-end lease gives consumers the possibility to rent a car for a specific period, which may run for 12 to 48 months in exchange for a fixed monthly rate. Upon receiving the lease, the lessee is not legally bound to purchase the car, but some terms are best to be respected.
Unlike the open-end lease, a closed-end lease has stricter terms that the lessee has to adhere to. If the lessee doesn’t manage to respect those terms, additional fees can incur that the lessee has to pay. Some of these terms are:
- Wear and tear - the lessee will pay any damage done to the car as the responsible party in the agreement for that particular car for that specific timeframe.
A closed-end lease agreement differs from the open-end lease agreement through the depreciation risk, and more importantly, who assumes it. During a closed-end lease agreement, the lessor bears the risk if the asset depreciates during the lease period as the lessee is not required to purchase the asset at the end of the lease. The lessor will sell it, and if the value of the asset depreciated, that is a loss for the lessor. Similarly, if the value of the asset has appreciated, that is a gain for the lessor.
Example of Closed-End Lease
During a closed-end lease agreement, Andrew leases a car evaluated at the $20,000 price, assuming that the vehicle will be assessed at $10,000 when the deal is finalized. The vehicle is leased for two years, and two years, Andrew pays his monthly lease payments. After those two years, the car’s value depreciated and is evaluated at only $4,000. Andrew respected the terms of the agreement, did not exceed the mileage limits, and took care of the car. Andrew can buy the vehicle for the assumed price of $10,000 and lose $6,000 of the depreciated value, or give the vehicle back going about his day.
If the car, however, appreciates and is evaluated at $14,000. Andrew can buythe vehicle for the assumed price of $10,000 and profit from its appreciated value, making a profit of $4,000 if he sells the vehicle. Or he can return it to the lessor.
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