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Imagine a world where you pay for gasoline bundled with your car loan payment in a single monthly fee. Now imagine that your car loan is paid off, but the monthly bill doesn't go down. In addition to paying for gas, you essentially keep making payments on the car for which you've already fully paid. No one in their right mind would sign up for such a crummy deal. In fact, if any company had the nerve to offer such a contract to poor saps, Congress would jump in and pass laws banning the practice.

And yet, that's exactly the raw deal most people in the U.S. are getting with their cell phone contract.

The crux of this scam is something called a subsidy. It's supposed to mean that your cell phone carrier “subsidizes” the cost of your phone. But all too often, what really happens is you subsidizing your carrier's profits.

Subsidies exist because mobile phones are, in fact, quite expensive. An iPhone 5 actually costs at least $650. If everyone was forced to pay that amount up front, it would deter a lot of people from purchasing new phones, which could in turn hold the industry back. Little Johnny would be more likely to get a Lego set for his birthday, instead of his first Android phone.

So to fight sticker shock, most phones are sold well below cost, thanks to a subsidy. That subsidy isn't free, of course. The carriers aren't that nice. You might pay $199 at the register for a new iPhone, but the carrier is subsidizing the remaining $400 - $450. This means around $20 of your monthly plan goes toward repaying that subsidy ($20 x 20 months = $400.) To make sure it gets its money back, the carrier locks you into a two-year contract. When the phone is paid off, the carrier will let you get another phone at the low (subsidized) price and, once again, pay it off over time, under a new contract.

That sounds simple and fair enough. But what happens when your 20 months are up, you're eligible for a new (cheap) phone, and you don't immediately get one?

Maybe you heard that a hot new phone is coming out soon and you want to wait. Or maybe your old phone works fine and you "just don't need a new phone yet.” Sound familiar? I hear friends and family members say things like this all the time.

So you wait. Your old phone is paid off. Does your monthly cost go down? Can you put your subsidy toward a future new phone? No.

You're still paying a subsidy. You're still paying for a new phone. But you're not getting that new phone. Your carrier is simply pocketing that $20/month and laughing all the way to the bank. You're being scammed.

You might think that you're in the clear if you bought an unlocked phone. Some major carriers offer “SIM-only” options for people bringing their own phone to the table. Your carrier may also let you pay full price for a phone up-front, and pair it with a traditional post-paid plan under what they call “month-to-month” service. This will save you from a two-year contract. But unfortunately, this is an even bigger scam. That's because, if your plan has the same monthly cost as if you were getting a discounted phone, then that plan includes a subsidy. That's $20/month down the drain, and it starts from day one. You paid full price for your phone and you're paying for one in your monthly plan. You're essentially paying for two phones but only getting one.

How do you avoid this scam?

One way to avoid the scam is to simply get a new phone the minute you're eligible. (Do not, under any circumstances, wait for the new iPhone that you heard Apple might announce soon.) The upside is that you can keep the major carrier you like, the coverage that works where you need it, the plan you like, and the best selection of hot new phones. The downside is that you're locked in a rigid schedule of getting a new phone about every 20 months.

You could also switch to a prepaid plan with your current carrier, or an all-prepaid carrier like MetroPCS, Cricket, Virgin, or Boost. With pre-paid plans, there's no contract, and the plans cost less per month since they don't include that subsidy. Of course, without a subsidy, you'll also pay full price for the phone up front, which can put a hurt on your wallet. MetroPCS and Cricket offer some financing options, but you have to deal with a third-party company, and they only spread the payments out over three months.

The other disadvantage of prepaid is the device selection. The big four carriers have severely limited prepaid phone choices compared to their post-paid lineups. MetroPCS and Cricket are doing a much better job of offering higher-end phones than they used to. For example, you can now get Samsung's Galaxy S III from both carriers. But they still don't have the all-star lineup that the big four do on post-paid plans.

T-Mobile is the only top-four carrier fighting subsidies head-on with a no-compromise option. They do offer “Classic” plans with traditional subsidies, but also “Value” plans that don't have a subsidy, and therefore cost significantly less per month. The Value plans are available with their main lineup of phones, not the limited prepaid lineup. They also offer an interesting option of paying for your phone with an “installment plan” instead of a subsidy. It's just like a subsidy, minus the scam. Your monthly bill simply goes down once your phone is paid off in 20 months. In fact, the phone installment payment is clearly itemized on your monthly bill, and it's less for cheaper phones, as it should be.

This gives you the flexibility to upgrade to a new phone whenever you like. This also gives you more options for managing your budget. When you reach the end of your 20 months and your phone is paid off, you can get a new phone, or - if money's tight - hold on to your existing phone for a while longer, enjoying your new, lower monthly bill. Perhaps you want to hold out for the new iPhone. Go ahead; you won't be penalized $20/month for waiting, as you would with a traditional post-paid plan.

We can only hope that all carriers will move toward a common-sense, consumer-friendly pricing structure like what T-Mobile is doing. In the meantime, don't get scammed.

Illustration by Charles Kline

Editor in Chief Rich became fascinated with cell phones in 1999, creating mobile web sites for phones with tiny black-and-white displays and obsessing over new phone models. Realizing a need for better info about phones, he started Phone Scoop in 2001, and has been helming the site ever since. Rich has spent two decades researching and covering every detail of the phone industry, traveling the world to tour factories, interview CEOs, and get every last spec and photo Phone Scoop readers have come to expect. As an industry veteran, Rich is a respected voice on phone technology of the past, present, and future.

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