While you can buy an iPhone for $199, iPhones have never actually been that cheap.

When you sign a two or three contract with a cell phone carrier, you agree to put up with frustrating service, ambiguous legalese, and a metric ton of hidden fees in exchange for a $200 subsidy on your phone.

Is the $200 worth two years of dealing with a company that just wants to get more money out of you? Probably not — but it sure helps sell iPhones like hotcakes.

So the iPhone 3GS is announced at WWDC and you’re happily heading over to Apple.com to dish out a couple hundred bucks for a new phone. Then the fine print stabs you through the heart:

For non-qualified customers, including existing AT&T customers who want to upgrade from another phone or replace an iPhone 3G, the price with a new two-year agreement is $499 (8GB), $599 (16GB), or $699 (32GB). Visit www.wireless.att.com for eligibility information.

No matter which way you try and spin it, $700 is a lot for a new phone. Logically, it makes sense. You’re paying $299 for the iPhone 3GS, $200 for the subsidy that AT&T would have paid, and $200 that was subsidized from your previous iPhone 3G.

The inherent problem with this is that you’re still under a new two year contract even after paying the full price for the new iPhone — essentially signing a contract with no new subsidy (akin to the original iPhone).

How to Work Around AT&T’s Cash Grab

For those that know how to navigate the cell carrier’s convoluted system, there is a workaround that, while still pricey, is significantly cheaper than going down the default upgrade path.

Last year, AT&T came out with an Early Termination Fee option that enables you to cancel your contract at any time for a flat fee of $175. Additionally, if you are more than 12 months into your contract, that $175 fee decreases by $5 every month.

In effect, it’s cheaper to cancel your current AT&T contract for $175 and purchase a brand new iPhone 3G subsidized for either $199 or $299 respectively. For the 32GB model, that’s a total of $474 instead of the $699 of going down the upgrade route.

UPDATE: Most 3G iPhone’s are available for special pricing until they become “upgrade eligible”. These upgrade prices vary depending on the length remaining on your contract. Most users are seeing $399 and $499, while some are seeing $499 and $599. This is an epic mess.

Even better, you get to keep a contract-free iPhone 3G which can be sold for a pretty penny online (read: $500+), making the total cost of upgrading to the new iPhone next to free.

And for all you complaining about AT&T, Rogers (the exclusive iPhone carrier in Canada) charges $500 to cancel your contract early. Then again, we get tethering first. So count your blessings.