The Rise of No-Contract Cellphones

Considering a prepaid cellphone to save money? Here’s what you need to know.

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With Apple's release of the new iPhone 5C and iPhone 5S last week, tech-hungry consumers will likely renew their cellphone contracts for another two years so they can get their hands on a shiny new iPhone at a price subsidized by their carrier ($99 to $199 compared to $650 or more without a contract). For those who aren't yet eligible for a two-year phone upgrade, carriers are also introducing plans like T-Mobile's JUMP! program that allow consumers to upgrade more than every other year.

At the same time, many consumers are opting out of two-year cellphone contracts that offer subsidized phones but keep them tethered to their mobile carrier. Instead, they're moving to prepaid month-to-month plans that offer greater flexibility. CTIA-The Wireless Association reports that 76.4 million consumers had prepaid plans in 2012, up from 71.7 million in 2011.

Mark Walters, a consumer electronics expert at TechBargains.com, is among those consumers. After he finished paying about $75 a month plus taxes during a two-year contract with a major carrier, Walters sold his iPhone on eBay, bought an Android phone and switched to a no-contract plan that cost about $35 for data and unlimited texting but fewer minutes (he says he never used all his minutes anyway).

Walters wasn't thrilled with the cell signal he got with his new carrier, so returned the phone and switched again to a no-contract plan with T-Mobile (in addition to smaller providers, many large carriers offer no-contract plans too). "The great thing about prepaid is you can switch at a moment's notice," he says. "No huge early termination fees."

[Read: How to Lower Your Cellphone Bill.]

Now Walters has a Galaxy Nexus and pays about $30 a month for a pay-in-advance plan with unlimited Internet use and texting and 100 minutes. "I couldn't be happier," he says. "The process wasn't without issues, but the savings more than made up for it."

Avi Greengart, research director for consumer devices at market intelligence firm Current Analysis, says the flexibility to switch carriers or change phones at will appeals to people who move around, especially those in the military who might be sent overseas. "If you move and you find that a different carrier offers better coverage, you aren't stuck with the contract," he explains.

Prepaid plans also appeal to consumers who may not qualify for a two-year contract because of credit issues. "[With a prepaid plan] the carrier isn't extending any subsidy to you, so they don't have to check if you're a good credit risk or not," Greengart explains.

Parents of teens may use prepaid plans to moderate minutes. "It's a great way to make sure that there are very clear limits and absolutely zero chance of overage," says Amy Storey, a spokesperson for CTIA-The Wireless Association. "Once you're done, you're cut off. You can always reload at any point, but it is an easy way for parents to keep track of their child's usage."

[See: 7 Hidden Smartphone Expenses.]

Prepaid plans once offered a limited selection of phones, but that's changing. Many now allow consumers to use smartphones, including iPhones. But here's the kicker: Those smartphones can cost $650 or more without a carrier's subsidy. "The vast majority of phones are sold with a two-year contract, and that two-year contract masks the true cost of the phone," Greengart says. "That's one of the reasons people like two-year contacts because they get a really high-end device without having to pay the really high-end prices upfront."

Carriers typically build the cost of the phone into the monthly cost of a two-year contract, so consumers who don't take the upgrade may be overpaying. "If you keep your phone for three or four years' time, you can save a lot of money by owning your phone and attaching it to a very low-cost service that meets your needs," Greengart says. Some carriers have moved to a hybrid model where consumers can finance the cost of the phone over the life of the contract, which is similar but more transparent than building it into the monthly cost.