I.    Introduction

 

Consumer automotive sales, one of the most interesting market environments, has  on one side consumers privy to a vast array of data, the availability of which has put them in a better bargaining position than they are aware.  On the other side are dealerships, armed with ever more creative methods of manipulating deals to try and increase profitability.   Neither side trusts the other.  Despite the explosion of data available online to consumers, they continue to be wary, often rightly so, of the information of which they are still unaware of when negotiating their car deal. 

            Disclosures are the key to breaking down this stalemate and allowing both parties to succeed.  By disclosing the information necessary for consumers to navigate their vehicle purchase, they will become less concerned that they are not getting a fair bargain and dealers will profit from the time gained, otherwise spent breaking down consumer apprehension.

            One area of automotive sales that remain shrouded in mystery is that of vehicle lease options.  This paper eliminates some of that mystery by describing various contract provisions included to the detriment of the consumer, defining the relevant financial terms that are omitted from all lease contracts, and suggesting statutory improvements to help correct these defects.  The goal is not to define the auto lease as an evil inflicted on unsuspecting consumers,[1] but to help understand the choice so that consumers can make informed decisions on whether a lease is a good idea for them.  This goal benefits the consumer and the dealer equally because an informed consumer is more willing to make a purchase and the dealer will therefore be able to better serve each customer and move on to the next.[2]

II.    Lease Terms/Provisions

The most obvious ways in which consumer automotive lease contracts are written to the detriment of consumers are the stated provisions on the back of the contracts. The purpose of this section is to review both the common and idiosyncratic provisions included in lease contracts.  These can range from standard forced arbitration clauses to demands that, “the vehicle will not have road, damage, chips, [or] scratches.”[3]  The reader should note, that in this particular industry a consumer does have the ability to choose a provider that does not require forced arbitration or many other provisions normally used to the detriment of consumers.   The chart below summarizes the contract terms to be discussed.  They can be broken down into two categories: waived rights and methods for default.   

 

Consumer Automotive Lease Contract Provisions

	FA[4]	Waive CA[5]	Additional Waivers	Default at Death	Driver L. Expires	User Restrictions	No Trailers Restrictions	No Scratches Restrictions
BMW	yes	yes[6]	no	yes	no	only spouse	no	No
Ford	yes	yes6	yes	no	no	no	no	no
GMAC	no	no	no	no	no	no	no	no
Honda/Acura	no	no	no	yes	no	no	no	no
Hyundai[7]	no	no	no	yes[8]	no	no	no	yes
Mazda (Chase)	yes	yes6	referenced	yes	no	yes	no	no
Mercedes	yes	yes	yes	yes	yes	no	no	no
Mitsubishi7	no	no	no	Yes8	no	no	no	yes
Nissan/Infiniti	yes	yes6	referenced	no	no	no	no	no
Subaru	yes	yes6	referenced	Yes	no	yes	no	no
Toyota/Lexus	yes	yes6	yes	No	no	yes	no	no
VW/Audi	no	no	no	yes	no	no	yes	no
Volvo (CULA)	no	no	no	yes	no	yes[9]	no	no
Volvo(USBank)	yes	yes	yes	yes	yes	no	no	no

1.     Waived Rights

The two main rights waived by consumers in some automotive lease contracts are the right to participate as a member of a class action and the right to a jury trial, by agreement to mandatory arbitration.  Though, the average consumer will rarely be affected by either provision, the consequences, particularly of the first, could be significant.  Bearing in mind that the lease contract has nothing to do with the vehicle itself but only with its financing, any claim brought by a consumer would be relatively small.  Examples might include overcharging late fees, or assessing unjustified damages at vehicle turn-in.  Because of this, it would be extremely rare that a single consumer would be cost justified in bringing an individual suit.  It was just this dilemma that initially justified the creation of the class action.  However, by waiving the right to participate each lessee essentially permits Vehicle Lessors to act with impunity against that type of justice. 

Interestingly, there seems to be no pattern between the relative luxury status of a brand and the existence or absence of these provisions in the brand’s contract.  Mercedes and BMW, for instance include them, but Acura and Audi do not.  This seems counterintuitive to the expectation that luxury buyers would be better-educated consumers, more wary of such provisions.  Similarly the bargain brands do not consistently include or exclude these provisions.   Additionally, though only eight of the fourteen major brands include the waiver of class action, six express it in a particularly deceptive way, by stating that both the lessee and lessor waive the right to participate.  Of course, it is nonsensical to imagine multiple manufacturers joining a class to sue a single consumer, and so the language’s only purpose must be to divert attention or inoculate the consumer against the risk, making it appear to be a shared one.    

The second commonly waived right, the right to a jury trial, is waived through agreement to mandatory arbitration.  It is problematic for a number of reasons, and there are many excellent articles discussing these.[10]

The reader should note that these provisions are not unique to lease, as opposed to finance contracts, and as such will not be a factor in considering how to purchase a vehicle, as they will likely be present whether a consumer chooses to lease or finance a vehicle through a particular manufacturer. 

2.     Methods for Default

Lease contracts contain a variety of provisions that place the lessee in default.  However, assuming that the customer makes the payments according to the lease, the manufacturers have very little incentive to place someone in default.  Manufacturers will almost always suffer a loss if they repossess a vehicle.  Therefore the provisions defining these conditions exist generally to ensure prompt payment and avoid lessor liability. 

For instance, many of the contracts state that other drivers may not drive the vehicle without written consent from the lessor.  Obviously, the lessor does not have inspectors watching the vehicles, confirming that only the lessee is driving the vehicle.  However, this provision does provide the lessor protection.  Aside from the obvious additional protection for the lessor from being named as a defendant in an accident caused by a party to whom they had not given permission, it also protects dealerships.  Customers aware that they cannot quality for a loan will sometimes ask a friend or family member to finance a car for them.  If a dealership suspects that that this might be occurring, they may not sell the vehicle.  By including this provision, the dealership and the lessor avoid some of the dangers of this occurring because the lessor may always claim not to have given permission to the driver not on the contract. 

However, other provisions seem to serve no purpose whatsoever.  Mercedes, for instance, includes a provision that the lessee is in default if his or her driver’s license expires.  Similarly, the Volkswagen/Audi contract includes a provision forbidding towing despite the fact that they lease vehicles rated to tow trailers.  In fact they offer vehicles for lease, which they advertise as capable of towing weights of 3500lb and 6600lb respectively. 

Hyundai and Mitsubishi, both of which use standard lease forms printed by dealership supplier, Reynolds and Reynolds, contain the boldest provisions of all.  “The vehicle will not have road damage, chips, scratches [or] cracks.”[11]  The presumption, of course, is that lessees whose vehicles suffer such common wear and tear are in default. 

III. Disclosures

Though all of these provisions present genuine unfairness to consumers, and prospective lease customers should be aware of the differences between manufacturers in those regards, a more immediate problem is posed by the layout of the contracts.  All fail to disclose key financial terms of immediate relevance to customers.

 Conventional loan contracts include amount financed, interest rate, term, and resulting payment.  Based on this information a consumer can use any number of online financial tools to corroborate these figures and calculate the amortization of their loan balance.  By contrast, a lease contract is far more complicated and the information does not provide a consumer the information necessary to corroborate the figures.  See below.

Before proceeding further, an explanation of how a lease works will be helpful.  A lease is an agreement to pay a certain portion of a vehicle’s value over a period of time.  The lessor generally advances this amount so that the lessee may pay a portion each month like a traditional loan.  However, in some cases the lessee will pay the full amount upfront.  Either way the calculations are made the same.  Two factors, the Manufacturer’s Suggested Retail Price (MSRP) and the Residual Value (Residual), are set based on the vehicle chosen, the lease term, and the mileage allotted.  The MSRP is simply the price on the window sticker of the leased vehicle, and the Residual Value, representing the estimated value of the vehicle at lease end, is calculated as a percentage of the vehicle’s MSRP.  The lessor will assign the percentage used for each vehicle for any given term and mileage option.   A dealer may not change either of these numbers. 

Ignoring any considerations for traded-in vehicles, the two other numbers required to calculate the cost of a lease are the selling price and the money factor.  The selling price may be negotiated like any other car transaction, and once set, any taxes, and government, lessor, and dealer fees, will be added to it.  The resulting figure will become the Gross Capitalized Cost.  Net Capitalized Cost will be calculated using this figure, less any down-payment made by the buyer.  The difference between Net Capitalized Cost and the Residual determines the Depreciation Amount upon which the lease payment(s) will be based.  Therefore, much like a traditional loan, negotiating a lower sale price or putting money down will result in a lower amount to finance.  Also, like a traditional loan, a charge will be assessed for advancing the money.  Interestingly there will still be a charge if a buyer chooses to pay the entire Depreciation Amount upfront, and not receive an advance from the lessor.  However, this charge is usually significantly less.  The charge is called a Money Factor and is applied to the Depreciation Amount to determine the Rent Charge.  The Rent Charge plus the Depreciation Amount will provide the total of the monthly payments, paid either per month or upfront. 

Much like any unconventional purchase option, these complicated calculations are designed to create an ideal scenario for all buyers.  However, there are many for whom it will present genuine advantages.  For consumers that do get a new car every three or four years, particularly one with an unpredictable resale value like some luxury cars, the lease presents buyers with the ability to avoid any downsides in the market by simply turning in the vehicle at lease end, or taking advantage of any upsides by exercising their right to sell the vehicle and retaining any profits if the vehicle is worth more than the Residual at the end.   As a result, very sophisticated clients often choose to lease.  However, because uniformed consumers are often seduced by the lower monthly payments that sometimes accompany a lease and are stressed by dealers, a variety of pitfalls exist and the absence of proper disclosures exacerbates this problem.   The rest of this section, therefore, will be devoted to exploring the valuable information omitted from lease contracts to the unfair detriment of an uniformed consumer.

1.     Beginning Balance

When a customer uses traditional financing to purchase a vehicle, they enter into a simple interest loan.  In other words, the balance of their loan on day one is the price they have paid for the vehicle plus any taxes and fees less any amount paid as down payment, or exactly the same amount as if they paid cash.  There are never any pre-payment penalties, and if for some reason a customer needed to sell their car the next day, they would only owe what they had agreed to pay for the vehicle.  Interest accrues through the loan period, but payments are amortized so that they will be the same each month.  

This is not the case for a lease.  Instead, the entire Rent Charge is added to the lease equivalent of amount financed, Net Capitalized Cost, from the beginning.  Therefore, if for some reason the buyer would like to sell, refinance, or trade-in the vehicle, from the very first day, they must pay for all finance charges that would have accrued. Given a reasonable Rent Charge estimate of 10-20% of the cost of the vehicle, a buyer of a $30,000 car could owe three to six thousand dollars more than a traditional finance customer on the first day of their loan.

In most cases this does not present a problem because, unlike finance customers, most lease customers will keep their vehicle through the end of their lease or at least close to it.  However, because lease customers, like any other buyer, often make purchases beyond their means or find their situation has changed and can no longer afford their vehicle, it should be required that they be informed of the increased exit costs.  Though the lease contract above contains no less than 47 dollar-amounts, used for calculation, it omits the single item required to solve this problem.  It does include, as do all lease contracts, an early termination section, stating “I may have to pay a substantial charge if I end this lease early.  This charge may be up to several thousand dollars.  The actual charge will depend on when the lease is terminated.  The earlier I end this lease the larger this charge is likely to be.”  While certainly a worthwhile statement to include, because buyers tend to look at numbers, a much more valuable use of space would be to simply state the beginning balance in a simple way so that the buyer may be aware of what his or her real obligations are.  While it may seem superfluous to add a figure, so easily calculated by adding the Rent Charge to the Net Capitalized Cost, to an already cluttered form, customers are clearly ignorant of it, just as many salespeople are, and its omission in spite of careful itemization of every other miniscule addition or subtraction can only indicate willful deception by the lessors. 

2.     Money Factor

As stated earlier the Money Factor is used to determine the rent charge of the Depreciation Amount, and as such, is the lease equivalent to an interest rate.  Most consumers would not recognize a money factor if they saw it.  In fact the number used is 1/24 of an interest rate, thus the equivalent of 5%(or .05) is .00208, and is displayed as a decimal number without conversion to percentage.  Because it so obvious that lenders must disclose the interest rate charged,[12] it is that much more shocking that lessors need not disclose their money factors. 

When dealers pitch leases they understandably focus on payments.  After all, there really aren’t any other costs involved from the average consumer’s perspective.   However, just like purchasing a vehicle there are two points of negotiation, the cost of the vehicle, and the cost of the money (financing), and the customer has a right to know what they are paying for each. 

Aside from the intrinsic value of information that in all other situations is provided as a matter of course, there are at least two specific reasons for requiring it here:  First, each manufacturer’s finance arm, acting as lessor, will offer different money factors, just as they offer different interest rates, for different models, customer credit rating, and term lengths.  Because of these differences customers may see drastic changes in the cost of leasing vehicles with very similar MSRPs from different or even the same manufacturer.  One factor contributing to these differences is that many customers frequently start leasing after discovering that they owe more than their financed vehicles are worth.  They can take that inequity, add it to their Gross Capitalization Cost, and finance it into their lease payment.  However, because this will increase the Depreciation Amount, they should minimize the money factor that will be used to calculate their Rent Charge from that larger amount.  Naturally, they should be made aware of it so they can make an informed decision on that basis.

   Second, lessors allow dealerships to increase the Money Factor that the customer is charged, usually up to the equivalent of 2.4% over the base rate.  This increase is given to the dealer, in whole or part, as increased profit.  It is true that one of the services that dealers provide is offering methods of financing so that customers need not pay for cars in whole, and arguably they should be capable of charging for this service beyond their profits from the sale of a vehicle.  However, in a competitive market, consumers should be aware of what each competitor is charging them, and by allowing dealers to withhold this information, the lease contract deprives the consumer of this information.  By requiring dealers to disclose this figure, consumers would know if one dealership for a manufacturer was charging a higher money factor than another, and this would allow consumers to properly negotiate their deal.

 In fact, disclosure of this figure might be to the benefit of both the dealerships and customers.  As, previously discussed, this sort of transparency tends to put customers at ease and more likely to make a purchase in a much less adversarial way because they are less fearful of being taken advantage of.  Therefore, if a competitive market dictates that dealers should be able to increase the money factor and collect extra profit then there is no reason why that fact should be hidden from consumers. 

3.     Taxes

Not all of the dangers of leasing, omitted from the contracts, are created by the lessors. In fact, states create an equally perilous pitfall.  An incredibly commonly used explanation of the customer’s options during the lease term is that at any time they can buy it, sell it, or trade it.  However, there is one important caveat that must always be relayed to the customer.  If at any time they would like to pursue any of those options from the first to the last day of the lease, they will first have to pay sales tax to the state in which the vehicle is registered on the balance paid for their vehicle.  The same is true even if they chose to refinance it.

The explanation is somewhat complicated.  When a customer leases a vehicle, they are assessed whatever taxes apply.  These vary from state to state.  Sometimes, for instance in Texas, the tax assessed is the standard 6.25% vehicle sales tax of the entire vehicle.  Other states, like Massachusetts, will add a lease specific sales/user tax to each month’s payment.  In either case the tax is paid by the lessee, on behalf of the lessor who of course retains title. Consequently, when the customer decides to buy it, sell it, or refinance it, they must first “purchase” the vehicle from the lessor and pay a sales tax to do so.  An exemption to this exists if the vehicle is instead traded in.

  That the states find it permissible to double tax lease customers in this way is made even more objectionable by the fact that they do not require dealers to disclose it.  Because the state is wholly responsible in this case, it is incumbent upon them to either correct the flaw in the tax system or inform their citizenry of it through the dealers by mandatory disclosures.  To date, we are unaware of any state so mandating this disclosure.  This dilemma is made all the more objectionable by the fact that those trying to get out of their leases are usually those in a tough financial situation.  They should have been made aware that the state, which exists for their protection, will exploit them, at that vulnerable time.

There are also various other types of taxes assessed by different states and counties through the term of a lease, and though it would take volumes to catalog them, any jurisdiction likewise burdening lease customers with taxes should force accurate and thorough disclosures of them at contracting. 

IV.  Model Statutes/End Game

Despite the auto dealers’ recent success at escaping federal oversight, there are still state agencies monitoring their activities.  The assigned agency varies by state and may include the state’s department of motor vehicles, attorney general’s office, or any other regulatory body.  By way of conclusion and synopsis this section provides guidance for those regulatory agencies should they choose to hold dealers to the correct standard when leasing vehicles. The statutory revisions required to correct these deficiencies in auto lease contracts are relatively straightforward.  From the standpoint of unfair provisions, the inconsistency with which they are included might be evidence of a competitive marketplace because for most onerous provisions it is possible to choose a manufacturer that does not include them.  The best of these are Honda/Acura and GMAC, the latter responsible for a great many vehicle lease contracts, including those for all Chrysler and GM vehicles. The class action waiver and forced arbitration are problems pervasive throughout consumer contracts, and the statutory correction to this must be an across the board outlawing of such provisions.  This issue goes well beyond the scope of this summary, but when the federal government does choose to take such action, they would be remiss in giving dealers the same exception that they have in the Dodd-Frank Act[13].   

When it comes to provisions like those included by Mercedes and VW/Audi of respectively, default through a driver’s license expiring, or using a vehicle to tow within the provisions set forth in product specification marked by the self same manufacturer, there is little justification for such provisions and they should be made void as a matter of law.  This can be done much easier through each state’s Secretary of State Office, or whichever state agency is responsible for establishing the governing rules for dealership operations. 

Similarly, immediate action should be taken to remedy the blatant omissions of relevant information from the lease contracts.  Unfair as the stated provisions on lease contracts are, at least consumers are given the opportunity to read them.  Whereas, most consumers will be completely ignorant of the information now withheld.  If the Secretary of States’ offices would require these disclosures, the consumer would, at the very least, be able to gather this information before signing the paperwork. 

Auto leases are not terrible.  In many cases they may provide significant advantages over other vehicle financing options.  However, a consumer considering that option should not have to rely on the salesperson’s good sense or honesty to ensure awareness of all of the data.  Rather it is incumbent upon the state to force dealers to disclose that information, both for the sake of protecting the consumers and to provide dealers with a better educated, less suspicious consumer with whom an easier and more mutually agreeable transaction may exist.