Cell Phones with No Contract: What’s the Real Deal?

Is a cell phone plan with no contract efficient?When T-Mobile became the first company to offer “no-contract” phones, many assumed it was the desperate attempt of an unprofitable company to gain some market share in a cutthroat industry. Other companies started to follow suit, and most assumed they did so defensively. Then, we started running numbers.

The cell phone subsidy used to be a form of advertising for the cell phone carrier. When high-end phones cost $200 and new ones came out every year or so, the carrier could eat the cost of the phone to ensure people continued to buy the service. The cost of the phone was built into your contract and the carrier made the money back over time.

Now, however, high-end cell phones cost $600 or more and come out every 6 months. The carriers no longer need the security of guaranteed monthly billing, mostly because cell phone ownership has moved from luxury to necessity. The market has changed, as have the economics behind cell phone purchase.

The traditional model of cell phone purchases got you a $200 subsidy discounted from the price of the phone if you signed a 2-year contract. That subsidy was built into the fees and extra charges on your bill, so the company made the money back over the course of the contract. When cell phone technology changed, an upgrade every two years was more than enough for most people, and the consistency of that business made life easy for companies.

You can still get the $200 subsidy and sign a two-year contract with Sprint and AT&T, although you may have to jump through some hoops to get it. Verizon continues to offer that program as its standard. In nearly every case, the subsidy and contract is a more attractive deal for consumers, but you may have to work for it. The heavy advertising of the no-contract option suggests that all three carriers may be phasing out the subsidy in favor of no-contract sales models. These no-contract plans also end up costing you more over the life of the contract, which is why the carriers are pushing them.

Typically, no-contract phone purchases offer two options. You can either finance the phone over a 2-year contract and pay nothing up front, or you can pay the entire cost of the phone up front and pay a slightly lower monthly bill. Which of these options works best for you depends on a few factors: how frequently you upgrade your phone, how expensive a phone you want, and your personal budgeting habits. Let’s take a look at how each of these factors plays into your decision.

Replacement Frequency

If you’re a gadget junkie who always needs the biggest and best in technology, no-contract phones are a big boon for you. You’ll want to pay up front for the entire cost of the phone and save a little bit on your monthly payment. You’ll have to shell out quite a bit up front though. The new IPhone 6, for instance, will cost $650 without subsidy. You can recoup some of that loss by selling your used phone, which you now own outright. This is probably the consumer behavior the carriers are trying to engineer. They know they make the most money when people buy a new phone and all the accessories while in their store.

If you’re much happier keeping one phone until it breaks, you’re probably better off financing the phone over the life of the contract. You can avoid the dramatic sticker shock that comes from the tremendous up-front cost, and if you get a cheaper phone, you can save some money over the long term. Your monthly bill will be somewhat higher than it is now, but that should drop once the financing is paid for.

Phone Cost

If you’re a loyal Apple consumer and want the new iPhone, you will be best off paying up front. The financing charges on that much money works out to a significant cost over the life of the contract. Your monthly bill will be a little lower, allowing you to budget a little more carefully for these purchases.

If you’re happier with a cheaper option, the financing structure might work better for you. This allows you to spread a much smaller cost over the lifetime of the contract. You can look for other ways to reduce your monthly bill to offset, like reducing your available data or abandoning a service you don’t use as much.

Life Stability

If you plan to move or have an unpredictable work schedule, the pay up front option may be worth your while. This option frees you from a monthly financing charge, enabling you to change carriers more easily. If you find yourself spending most of your time without service, you can change carriers to find one that may offer better coverage where you spend most of your time.

If you’ve got a routine, that flexibility may not matter as much. You’re happy with your carrier and the level of service it provides. You might be better off without the significant up-front cost involved in paying for an unsubsidized phone.

Do you have experience with a no-contract phone plan?  Please share your pros and cons in the comments section below.

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