How to cancel a credit card -- the right way

Do not call to cancel a card if you still have a balance. If the card issuer knows you are thinking about leaving, it could raise your interest rates to the maximum allowable by law as a penalty for closing the account, if you do so with an outstanding balance.

Some companies will allow you to cancel without even talking to a customer service representative. Others will transfer you to a special department for the sole purpose of trying to convince you to not cancel your card.

Steve Rhodes, past president of Myvesta.org, a financial crisis treatment center, suggests you spend a little time listening to the representative. They might be willing to lower your interest rate, offer a two-for-one airline ticket, or upgrade your standard card to platinum. Carefully consider the ramifications of keeping the card open. If you are in the process of reducing the number of credit cards you carry, then cancel a different card.

If no such offers are made, or appeal to you, then go ahead with the cancellation and do not allow the representative to convince you otherwise.

Follow up with a letter
Write a short letter to the card issuer. "If you can get a name so you can send it directly to someone, that is better," Brannan says.

The letter should say that you're closing your account and that you want your credit record to reflect the fact that you requested that the account be closed. Provide your name, address and account number.

Send the letter by certified mail or return receipt requested. That way you can prove that the card issuer received your letter, Brannan says.

Then, wait a month.

"You can allow as much as 30 days for the closing of your account," Brannan says. "Then get a copy of your credit report and make sure it says 'Closed at customer's request' and that (the account) actually has been taken off your credit report."

Check your credit report
You don't want your report to say the account was 'closed by creditor,' because that reflects negatively on you.

If the card issuer mistakenly reported that the issuer, not you, closed the account, you'll have to return to the beginning. Call the customer-service department to report the mistake, follow up with a letter sent by certified mail (include a copy of the letter you wrote requesting that the account be closed), and check your credit report again.

"Remember that a credit report is your credit history," Brannan says. "The information is submitted by lenders, but it's your individual responsibility to make sure it's correct."

Believe it or not, it's not the credit bureau's responsibility to make sure that your credit report is correct. Credit bureaus report what creditors tell them. So if your credit report is inaccurate, don't ask the credit bureau to fix it. Ask the creditors to correct inaccuracies and update the credit bureaus.

Experts recommend that you check your credit report annually to spot inaccuracies and detect identity-theft problems. Check your credit report before buying a house or car so you can correct any problems before applying for a loan.

Why not to cancel
But not everyone should start canceling all kinds of credit lines. If you're planning to buy a house or car soon, you might want to hang on to your unused credit lines until after you've qualified for a loan.

"If your goal is to improve your credit score, closing accounts is not a good tactic," says Craig Watts, consumer affairs manager for Fair, Isaac and Co. based in San Rafael, Calif. "Paying down credit cards is terrrific. Closing them is not going to help."

Canceling a large amount of unused credit could actually hurt your credit score.

Credit-scoring models look at a number of factors when calculating your score, including the result of the following formula: The total amount of debt on credit cards and revolving accounts divided by the total amount of debt available on those accounts.

This formula results in a fraction less than one. The lower the fraction the better. A score of one would mean your outstanding debt equals your available credit and you've maxed out your cards.

Let's look at an example. Let's say you've got $5,000 of debt and $15,000 in credit lines. By dividing 5,000 by 15,000 you get one-third. You're using one-third of the credit available to you.

Now let's say you cancel an unused credit card with a $5,000 limit. You've still got $5,000 of debt but only $10,000 in credit lines. By dividing 5,000 by 10,000 you get one-half. You're now using one-half of the credit available to you.

The closer to one this fraction gets, the more it hurts your credit score.

"When you cancel unused credit cards without paying down your credit debt, you change that ratio so it appears as though you're closer to being overextended," Watts says.

The best advice for a home or auto shopper is to hang on to credit lines until after you've landed your loan.

"Wait until you've been approved for the loan and have the money in hand, and then start closing accounts," Watts says.

If your credit card balance is zero, go ahead and close as many unused accounts as you want. As long as your credit cards are balance-free, it won't hurt your credit score a bit. So call those card issuers and cut away.

If you're in credit trouble or if you had credit problems in the past and you know an open credit line is just going to tempt you to spend -- go ahead and close the account.

Yes, it may ding your credit a bit. But if it will keep you from acquiring more debt, it's best to do it. You can worry about building up your credit score after you're back on your feet financially.