Debt settlement can be a tempting solution when you’re overwhelmed by debt and don’t want to deal with negotiating with creditors to reduce the total amount owed. However, it's crucial to fully grasp the perils associated with debt settlement to make informed decisions about your financial future, ensuring potential risks do not blindside you.

Debt settlement sends a negative signal to creditors—once a debt settlement company contacts a creditor, your account will likely be closed. Creditors extend credit based on risk, and debt settlement indicates you cannot pay your obligations. To mitigate losses, creditors close your account. Many debt settlement companies may require you to close your credit accounts.  The closure of credit accounts negatively impacts your credit score since credit scores are based on open accounts you are actively paying. Settled debts are typically reported as "settled" or "paid for less than the full balance," which also hurts credit scores.

Another peril of debt settlement is the risk of facing tax consequences. Forgiven debts may be considered taxable income, meaning you could end up owing taxes on the amount of debt forgiven. It is crucial to know these potential tax implications and consult with a tax professional to understand the full scope of the financial consequences. Any debt forgiven of $600 or more is considered taxable income. 

Many debt settlement companies advise you to miss payments to enhance the ability to negotiate a reduction in your debt. Unfortunately, credit scores are heavily based on credit history, and delinquencies can be devastating. You should always make payments you can afford. It’s better to contact your creditors to indicate a hardship or negotiate lower interest rates, remove fees, and adjust payment schedules and amounts. This will enable you to reduce your load and preserve your credit accounts.

If you need to catch up or are deeply stressed about your debt, consider debt management or consolidation loans.  Debt management companies help you negotiate lower payments and consolidate your debt into one monthly payment. Debt consolidation loans can enable you to consolidate your debt into one lower-interest-rate loan, saving you money over time and enabling one payment. However, this option is best pursued before delinquency as most lenders seek credit scores of prime 670 or higher. 

While debt settlement can provide relief in the short term, it's vital to consider the long-term implications. Settled debts have lasting effects on credit scores, and managing the aftermath of debt settlement requires careful financial planning to rebuild credit. These negative marks will stay on your credit report for seven years. The consequences can lead to ongoing financial challenges and hinder future goals, such as purchasing a home or a car. Your ability to borrow and interest rate will be determined based on your credit score. The lower your score, the less likely the approval and the more costly credit will be for you.