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Why buying a smartphone off contract is so expensive

black and white iPhone 5 models

You might not realize it, but if you have a modern smartphone in your pocket, you're carrying one of the most high-tech devices in the world. At the time of writing, the latest and greatest iPhone 5, without a service plan, starts at $649. By comparison, a powerful home computer from a manufacturer like Dell — one that will last you a good few years — can cost as little as $500.

How, then, does a mobile operator like AT&T offer the iPhone 5 for as little as $199? It's all thanks to a little thing called a "subsidy lock" or "SIM lock." When you buy a phone from AT&T, AT&T subsidizes your cell phone; it pays the full $649 to Apple. In return, you can only use your phone with AT&T. That's why you are forced to enter a 2-year contract when you buy the phone; if you were to go off the grid without paying for the phone, AT&T would be out that amount. This is also why carriers charge you an Early Termination Fee if you break your contract.

How it adds up
Even though smartphones are usually marketed at an attractive price, you can be guaranteed that the monthly service plan charge will not be cheap. The minimum monthly fee for a data-and-calls plan with AT&T is $59.99, and you have to pay that for at least two years, for a total of $1,439.76. Add $199 for the phone and $36 for activation, and the total cost of ownership come to just under $1,675.

On the other hand, if you buy the phone separately, unlocked, for $649, you still need a data plan before you can use it in the U.S, but you won't be subject to early termination fees or a locked-in carrier contract.

So which is better?
There's no doubt that a contract smartphone is cheaper over two years, and you get more for your money, but at the cost of flexibility. If your situation changes — if you move to an area with poor AT&T coverage, for example — you're stuck with a very attractive door stop.

On the other hand, if you opt for the contract-free approach, there is a wealth of options. You can buy a second-hand phone from eBay or pick up a phone that isn't available from U.S. mobile carriers. You can switch between service providers whenever you like — and you can terminate whenever you like, too. You can also change your phone at any time, which is handy if you want to always have the latest and greatest phone. In the long run, though, you ultimately pay for that flexibility with your hard-earned money.

Subsidized or not, smartphones are expensive
No matter how you slice the pie, you're still going to be spending more than $1,600 for two years of smartphone usage — and that's with the cheapest data plan on offer. Want to know more about the advantages of eschewing a carrier subsidy and going the unlocked route? Read up on our guide to the advantages of unlocked devices or take a gander at Google's unlocked Galaxy Nexus.

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