China Apple's Challenge
Ng Han Guan/AP
Analysts anticipate that Apple's (AAPL) next iPhone could be its best-selling yet. The device, which is expected to have a larger screen, could attract both longtime Apple fans and Android converts alike.

Consumers planning to pick up the phone will have a choice: The major U.S. carriers, including AT&T (T) and Verizon (VZ), now allow their subscribers to forgo the once standard two-year contract and instead finance their phones on a monthly basis.

According to Consumer Intelligence Research Partners, the popularity of phone financing plans is growing steadily. In the first quarter of 2014, about 25 percent of all new smartphones purchased were paid for with financing plans, up significantly from a year ago, when these plans were virtually unheard of.

Should consumers planning to get Apple's next iPhone stick with the standard two-year contract or choose one of these plans?

The Benefits of Phone Financing

With a phone financing plan, the cost of service is kept separate from the cost of the handset. This means that monthly bills will vary depending on which handset the customer chooses -- someone with Apple's latest iPhone will (usually) have a higher monthly bill than someone using an older iPhone. This contrasts with the standard two-year contract model, where the monthly bill was constant no matter which phone was chosen.

Phone financing brings a number of benefits. For starters, those who opt for cheaper phones are rewarded with lower monthly bills.

Consider a hypothetical AT&T subscriber: One line with 2GB of data costs $65 a month on AT&T's Mobile Share Value Plan. Purchasing a phone with a two-year agreement adds an extra $15 a month to the bill. After 24 months, that's a difference of $360.

Phone financers also avoid expensive down payments. On both AT&T and Verizon, those who opt for a two-year agreement must shell out $200 for Apple's iPhone 5S. If the phone is financed instead, subscribers may owe nothing at the time of purchase.

But that doesn't make the handset free. Instead of $200 up front, they'll pay $32.50 a month for 20 months, in addition to the costs associated with their chosen service plan (in this example, $65). For a new line, with a single smartphone and 2GB of monthly data, an AT&T subscriber financing Apple's iPhone 5S will pay $97.50 every month. A subscriber who chooses a contract will have to shell out $200 up front, but the monthly bill will be only $80. (The pricing for Apple's iPhone 6 hasn't been revealed, but if recent history is any indication, will likely be offered for a similar price.)

After two years, the AT&T subscriber on the two-year contract will have paid $2,160 for an iPhone and service ($200 plus $80 a month for 24 months plus a $40 activation fee). The subscriber who opts for financing will have paid $2,210 ($97.50 for 20 months, then $65 for 4 months) -- $50 more.

Two-year contract Phone financing
Cost of the handset $200 $650
Cost of the service $1,920 $1,560
Activation fee $40 $0
Total cost after 24 months $2,160 $2,210

With Verizon, the contrasts are far more stark. A customer who opts for a two-year agreement will, after 24 months, have paid $2,395 ($200 plus $90 a month for 24 months plus a $35 activation fee). If a Verizon subscriber opts for phone financing instead, they will pay $2,605 ($112.50 a month for 20 months, then $80 for four months and a $35 activation fee). In total, that's a difference of $200.

Two-year contract Phone financing
Cost of the handset $200 $650
Cost of the service $2,160 $,1920
Activation fee $35 $35
Total cost after 24 months $2,395 $2,605

So, while phone financing is more expensive in absolute terms, there are other things -- such as freedom from being tethered to a particular plan or a phone model -- that make this pricing model attractive to certain customers.

Because phone financers are, technically speaking, not tied to their chosen carrier, they do not have a contract and can cancel service at any time. However, that flexibility comes at a price: If they choose to cancel, they must pay the entire outstanding balance of their handset.

Consumers who like to have the most up-to-date technology may be attracted to policies like AT&T's Next and Verizon's Edge that allow smartphone owners to upgrade to the latest handset. That means that next year, someone who financed Apple's iPhone 6 could, if they so choose, upgrade to Apple's 2015 model.

Still, upgrading to the latest smartphone is in many ways similar to leasing a car. After a certain number of monthly payments (on Verizon, for example, 60 percent of the handset's original cost must be paid), subscribers are allowed to exchange their existing phone for a new one. However, the amount of money paid toward the original handset resets, and the monthly payments continue in perpetuity.

Finance or Sign a Contract?

For someone planning to purchase Apple's iPhone 6, the question of financing or signing a contract depends largely on whether they can afford the up-front down payment. Unless they absolutely cannot afford to shell out the $200 at the time of purchase, they will save more money with a two-year agreement in the long run.

AT&T's Next and Verizon's Edge may be attractive to gadget enthusiasts but can be quite costly. Unless a customer absolutely must have the latest phone, it still makes far more financial sense to upgrade every two years.

Motley Fool contributor Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple.


iPhone 6 Rumors: What to Expect

Increase your money and finance knowledge from home

Intro to different retirement accounts

What does it mean to have a 401(k)? IRA?

View Course »

How to Buy a Car

How to get the best deal and buy a car with confidence.

View Course »

Add a Comment

*0 / 3000 Character Maximum

7 Comments

Filter by:
Stephen

Most likely there is only one decent, efficient cell phone service in your local area. When you buy a new phone…go with their 2 year contract (you would be spending two years with them anyhow) and that will lower the cost of the phone down from $600 or so…to $100-$200. Keep that phone for the next 2 years…and then do it all over again. For $100-$200 every two years....you will, for the most part, always have a relatively updated version of your favorite phone.

July 20 2014 at 7:49 AM Report abuse rate up rate down Reply
puxer181

Only idiots buy a new phone every year , people that money is no object,or lack of common sense..

July 09 2014 at 12:08 AM Report abuse +1 rate up rate down Reply
1 reply to puxer181's comment
true.liberal

Who said anything about buying a new phone every year (except you, of course)?

July 09 2014 at 9:53 AM Report abuse rate up rate down Reply
ted_wilson7

What's the Best Way to Pay for Your iPhone 6?…..cash

July 09 2014 at 12:07 AM Report abuse rate up rate down Reply
drpmindmender

The best way to buy a new iPhone 6, is to save your money, and not buy one at all.

July 08 2014 at 6:28 PM Report abuse +1 rate up rate down Reply
2 replies to drpmindmender's comment
Sterling&Skyler

yep ^

July 08 2014 at 7:30 PM Report abuse rate up rate down Reply
true.liberal

You could save some real coin by turning off your water and electricity too.

July 08 2014 at 8:42 PM Report abuse rate up rate down Reply