Debt settlement, or agreeing to pay a creditor less than you owe, should be avoided, if possible. It's a huge mark against your credit score, and the fees and taxes you pay as a result of the settlement may offset what you save by paring down the debt.

A less-drastic measure such as debt management may resolve your dilemma. That's why it's important to get credit counseling as soon as you see the warning signs: Your income is too low to keep up with your debt or you're borrowing from one creditor to pay another.

"When you reach that point, you need to get some advice on what options are there for you, whether it's working on your budget, doing some kind of debt-consolidation loan, free advice from a credit counselor, debt settlement or bankruptcy," says Russell Graves, president of the Association of Credit Counseling Professionals.

If it turns out debt settlement is your best option, the good news is that many creditors are now willing to negotiate, says Mary Jackey, spokeswoman for the Consumer Credit Counseling Services, based out of Columbus, Ohio.

Don't wait; be proactive

Don't wait until your account has been charged off, which generally happens when your payment is more than six months behind. A charged-off account is a term that the lender uses to reflect that his prospects of getting repaid are slim. It doesn't mean that you no longer owe the debt.

"If you are going to contact your creditors, do it quickly," Jackey says. "Don't wait and think the creditor is going to go away."

As long as your debt hasn't already been written off, some creditors may be willing to talk about debt settlement as your account becomes more delinquent because they see it as a loss risk. But Jackey points out that if you act early, you may have other options, such as formulating a debt management plan that lets you pay the debt in full and salvages your credit score.

"In this economy, creditors are often trying to do loss aversion, where consumers and creditors work together to have a positive outcome," she says.

Don't overlook the consequences

"Any settlement for which the forgiveness of debt is greater than $600 becomes a taxable event," Graves says. "If somebody were to settle a $10,000 debt for $5,000, the $5,000 becomes taxable."

Graves adds that debt settlement also has a negative impact on your credit report and your future ability to borrow money at an affordable interest rate.

"The credit report lists the account as settled or paid for less than the amount owed," he says. "That is an indication to future creditors that you borrowed money but couldn't pay it back."

Be prepared to show your financial cards

Before they agree to settle your account, creditors will ask for documentation of your income, your assets and all of your existing debts. They'll want convincing proof of your hardship.

"They want to make sure that the person they are going to be offering this settlement to cannot pay (the full debt) and is not just looking to save some money ... and that the only way they can expect to get some of their money back is through some kind of concession," Graves says. "They don't want to offer concessions to individuals that just want a deal."

Don't make a promise you can't keep

If your creditor is letting you pay the debt settlement over time, set the payments at a level you can manage financially.

"We encourage our clients who negotiate directly with their creditors to make sure that they do not set a settlement plan that is unrealistic," Jackey says.

Those who promise too much may be able to make only the first payment in the debt settlement and then have to default because they can't keep up with the rest of the schedule. When that happens, the account is referred to a collection agency, she says.

Make sure the matter is settled

If you pay a debt settlement, find out if it shows up properly on your credit report. Jackey says some creditors fail to report settlement payments to credit bureaus even though they are required by law to do so, leaving the consumer's credit report showing their accounts as indefinitely delinquent.

"Sometimes a client will come in to us with a credit report that doesn't even show that a portion of the account was written off. It shows that the full balance is still owed," Jackey says.

Also, make sure that creditors stop calling and sending debt collection letters in exchange for your payment plan, she says.