Cut the contract: How prepaid smartphones can save you money

Smartphones may make our lives easier, but boy, they sure do make our wallets lighter. A typical smartphone setup with one of the major U.S. carriers costs around $70 to $80 a month -- and that's on the lower end of the spectrum. So what if there were a way you could get the same kind of service for less than half the cost?

It turns out there is -- if you're willing to make a few trade-offs. The secret lies in a rapidly growing but rarely discussed segment of the smartphone market known as prepaid or contract-free service. Prepaid service has been around for some time, but in the last couple of years it's started to transform from a source of cheap, bottom-of-the-barrel phones into a viable outlet for compelling smartphones.

So what exactly do you give up by going the prepaid route and is the sacrifice worth the gain? Read on; you might just be surprised.

The prepaid evolution

The U.S. prepaid phone market started out with a simple purpose: To provide inexpensive phones and wireless service to people who were unable to secure regular contract-based accounts.

"If you look back three or four years ago, prepaid was really a destination you landed as a consumer if you couldn't pass a credit check," says Mike Katz, the head of T-Mobile USA's prepaid division.

Planning to switch to prepaid?

If you're thinking of trying a prepaid smartphone, there are a lot of decent ones to choose from. We look at six worthy contenders in our slideshow:

6 standout smartphones for prepaid plans.

As technology and consumer demand have evolved, though, so too has the focus of the prepaid phone market. While some carriers still strive to serve what Katz describes as the "mobile minimalist" population, much of the effort these days revolves around luring in a new generation of data-hungry subscribers.

"In addition to customers who need no contract, there's an emerging market of customers who just don't want a contract," explains Lynne O'Donnell, brand manager of Sprint-owned Virgin Mobile USA. "Consumers more and more don't understand why they have to be in a two-year contract in order to get great service with devices that are current."

The shift may not be in-your-face visible -- the big-name carriers spend copious amounts of cash promoting their contract-based plans while prepaid carriers tend to market far more conservatively -- but it is undoubtedly present. Of the phones bought in 2011, 27% were prepaid, according to market research firm NPD Group, a growth of 8% from a year earlier.

Even more noteworthy is the fact that, within the prepaid mobile market, sales of smartphone-style devices more than tripled over the past year: NPD found that 35% of all prepaid phone purchases were smartphones in the fourth quarter of 2011 compared to just 11% in the fourth quarter of 2010. Some carriers are seeing an even more extreme evolution: On T-Mobile's network, for example, a whopping 60% of prepaid phone purchases in the fourth quarter were smartphones.

"Prepaid is one of the fastest growing smartphones segments in the U.S.," says Ross Rubin, a principal analyst with the NPD Group. "It tends to be a market of less affluent consumers and younger consumers, but they are highly mobile and they live on their smartphones."

The prepaid proposition

So how does this whole prepaid thing work? In a typical "postpaid" smartphone scenario, you agree to stick with a carrier for a couple of years when you buy a new phone. In exchange for that commitment, the carrier subsidizes your phone purchase, taking as much as several hundred dollars off the cost of the device. Then you get a bill each month for the previous month's service, factoring in any add-on fees and overage charges ("ways they screw you over," to use the technical term).

With prepaid service, everything is flipped upside down. You sign no contract. You usually pay the full cost for any phone you decide to buy, with no carrier-provided subsidy. And you pay a set flat fee up front for each month's service. That means when it comes to your bill, there are no nasty surprises.

"It's a sense of control," says T-Mobile's Katz. "Since you pay in advance for your service, the idea of overages and spending more than what you signed up for isn't a concern."

In terms of cost, you can find reasonable prepaid smartphone plans for as low as $25 a month. T-Mobile's Monthly4G service, for example, has a $30-a-month prepaid plan that provides 100 minutes, unlimited texting and unlimited data; you get your first 5GB at 4G-level speeds, but if you go over 5GB, you're throttled down to a dial-up-like crawl. On Virgin Mobile, which uses Sprint's network, $35 a month gets you 300 minutes, unlimited texting and unlimited data with your first 2.5GB at 3G-level speeds.

Compared to the postpaid world, the difference is striking. The lowest contract-based smartphone plan on T-Mobile's regular service costs $70 a month; it gives you unlimited minutes, unlimited texting and a meager 200MB of high-speed data. For a more manageable 2GB high-speed data allowance, your monthly cost jumps up to $80 a month.

The other big carriers are no cheaper: Sprint charges $80 a month for 450 minutes, unlimited texting and unlimited data; AT&T charges $70 a month for 450 minutes and 3GB of data; and Verizon charges $70 a month for 450 minutes and 2GB of data. If you want unlimited texting on the latter two of those two networks, be prepared to tack on an extra $20 to your monthly bill. And if you go over your monthly data allowance, be prepared to pay extra for that, too: Instead of throttling your speeds down, as many of the prepaid carriers do, AT&T and Verizon charge you an extra $10 for every gigabyte (or portion of a gigabyte) you use beyond your limit.

Overage handling aside, the basic data allotments are fairly consistent between the prepaid and the postpaid configurations. Most midrange prepaid plans give you 2GB to 5GB of high-speed data usage per month. The comparable midlevel postpaid plans give you 2GB to 3GB. (Sprint is the one exception; it's the only major U.S. carrier to still offer truly unlimited data to new subscribers, both through its regular postpaid service and via its prepaid Boost Mobile brand.)

Generally speaking, you're no more likely to hit a data cap while using a prepaid plan than you are while using a traditional postpaid arrangement.

Device decisions

Hold the phone: With these price differences, why would anyone not go for a prepaid plan? Are those of us stuck in the postpaid world just flat-out crazy?

Not necessarily. Prepaid plans do have their drawbacks, and device selection leads the list.

"We're still not seeing the kinds of leading-edge devices in prepaid that would be flagships at carriers like Verizon," says NPD's Rubin.

In other words, you won't find a hot, top-of-the-line device like the Samsung Galaxy Note or the iPhone 4S (or any iPhone, for that matter) at a prepaid carrier. You will, however, find plenty of decent midrange smartphones like the Android-powered LG Marquee, available for $280 from Boost Mobile, and the LG Optimus Black, available for $329 from TracFone-owned Straight Talk. And while you might be able to get a higher-end phone for the same money from a major "postpaid" carrier, when you factor in the two-year contract and higher monthly service rates, you'll end up paying far more in the long run.

Just ask Jeromy Shepherd. A family man from Illinois, Shepherd spent hundreds of dollars on smartphones with big carriers before deciding to look into prepaid alternatives. He ended up with Virgin Mobile, where he uses an HTC Wildfire S phone and pays about $40 a month for 1200 minutes and unlimited texting and data (with the first 2.5GB at 3G speeds).

"I have cut the family cell bill to near a third of what it was with AT&T," Shepherd says. "And the math proves that the total cost of the [postpaid plans from] big companies far exceeds the upfront cost of buying the phone outright from Virgin."

Kristofer Gigante came to the same conclusion. Gigante, a high school teacher in New York, uses the LG Optimus V (which, as of this writing, sells for $100 ) on Virgin Mobile. Two weeks after he bought the device, his wife decided to get one, too.

"It made no sense to me to pay all the money people do for their contract phones," Gigante says. "For $50 a month, we have two Android smartphones, unlimited texting and data, and 300 minutes of talk each."

Some crafty smartphone enthusiasts have even found a way to use top-tier devices with prepaid prices and no contractual commitments. John Bowdre, an IT manager and self-proclaimed geek from Alabama, uses Google's flagship Galaxy Nexus phone on T-Mobile's Monthly 4G service. He's on the $30-a-month plan that includes 100 minutes, unlimited texting and 5GB of 4G data.

Bowdre's trick: He bought an unlocked GSM version of the Galaxy Nexus from a third-party retailer. He paid about $560 for the phone, got a T-Mobile SIM card -- T-Mobile allows you to bring any compatible device onto its network with a prepaid plan, regardless of where you bought it -- and signed up for service. The up-front cost of the phone may seem high, but as Bowdre realized, he was still coming out ahead in the end.

"Saving roughly $50 a month, I'll offset the purchase price of my phone in less than 12 months," he says. "What part of prepaid doesn't make sense?"

His logic is sound: If you were to buy the Galaxy Nexus with a two-year contract from Verizon, you'd pay $300 for the phone. For 450 minutes a month -- Verizon's lowest talk option -- along with 5GB of monthly data and unlimited texting, you'd fork over a total of $110 per month. Over the course of a two-year contract, that'd come out to a grand total of $2,640. Factor in the cost of the phone, and you're looking at an investment of $2,940 for the device and two years of service.

With T-Mobile's $30 Monthly4G plan, on the other hand, you're paying only $720 in service charges over the same two-year span for 100 minutes a month and the first 5GB of data at 4G speeds. With an up-front device cost of $530 -- the current (as of this writing) unsubsidized cost of the GSM Galaxy Nexus on NewEgg -- that comes out to a total two-year investment of $1,250, which is less than half the total cost on Verizon. If you can manage with the smaller pool of minutes, the potential savings are enormous even with a high-end phone.

Prepaid perspective

Before you drop everything and put all your eggs in the prepaid basket, there are a few more downsides worth discussing. Beyond the aforementioned device consideration, prepaid carriers tend to have far more limited plans than their postpaid counterparts. You typically won't find shared family plans on prepaid, for example, nor will you find the types of multiple-service discounts the larger carriers can provide.

Then there's the issue of minutes. With prepaid, you get the number of minutes you pay for, plain and simple. If you sign up for 100 minutes a month, you get 100 minutes a month -- no free nights, no free weekends, no free mobile-to-mobile calls, and no month-to-month rollovers. You can get additional minutes if you need them, in most cases, but only if you post the funds onto your account in advance. With T-Mobile's $30 plan, for example, extra minutes are billed at $0.10 each if you activate an "autorefill" feature and maintain an appropriate prepaid balance.

Some of the prepaid carriers are also smaller regional companies that offer relatively limited coverage and don't support 4G-level data. If you do decide to go prepaid, be sure to think carefully about your carrier choice and make certain the company you choose provides the type and size of network you need.

Finally, prepaid carriers may not always offer the same level of support that the larger carriers can deliver. This can manifest itself in the form of slow or sometimes nonexistent software upgrades and lower priority call handling. Of course, one could contend that the big carriers have pretty mixed track records when it comes to those areas, too, so take the contrast for what it's worth.

Ultimately, the prepaid phone market is a vastly different entity from what it was just a couple short years ago. With its expanding focus on smartphones and ever-increasing variety of plan options, the compromise it requires is now smaller than ever. It may not be the right choice for everyone, but with the way things have evolved, any smartphone shopper would be wise to explore the prepaid possibilities before habitually settling into a postpaid carrier commitment.

Check out our slideshow: 6 standout smartphones for prepaid plans.

JR Raphael is a Computerworld contributing editor and the author of the Android Power blog. You can find him on Google+, Twitter, or Facebook.

Read more about smartphones in Computerworld's Smartphones Topic Center.