Bankruptcy is the option of last resort for people with overwhelming debt problems. When you file for bankruptcy, you are asking a bankruptcy judge to approve a plan that divides whatever assets you have among your creditors (the people and businesses you owe money). You may also be asking the court to discharge or cancel your debts if you do not have enough money or property to pay the debt. In return for a very visible and long-lasting black mark on your credit record, bankruptcy allows you to pay what you can to your creditors and walk away from your debts.

It’s actually fairly simple. Working with an attorney, you file for bankruptcy in federal court. The filing fees aren’t very expensive. Attorney’s fees vary widely.

You choose between two personal bankruptcy options: Chapter 7 and Chapter 13. The court reviews your finances and decides whether to allow you to file for bankruptcy, and which of the two bankruptcy options is right for you.

Chapter 7 and Chapter 13 bankruptcy

Chapter 7, known as straight bankruptcy or liquidation, is the more drastic step and historically has been the more common choice. (Recent legislation has made it more difficult to gain a court’s approval to file for Chapter 7 bankruptcy, and courts are steering more people to Chapter 13 bankruptcy.) Here’s what happens in a Chapter 7 bankruptcy:

* If the court grants your bankruptcy petition, a court trustee decides which of your assets you can keep. These are called exempt assets. Different states have different rules about what you can keep in order to move on with your life. A federal code applies in all states, and you can choose whether to have your assets reviewed under the state or federal guidelines. Under the federal code, exempt assets include

- a portion of the equity you have in your home (up to $17,425 in 2003) if you commit to keeping up with mortgage payments

- your car, truck, or motor vehicle (up to $2,775 in value in 2003) or a small amount of equity in your car if you commit to keeping up with loan payments

- jewelry (up to $1,150 in 2003)

This is not a complete list, just a sample to show some of the more commonly used exemptions. Basic household furnishings and work-related tools are also exempt in most states, for example. The dollar amounts are for an individual. If a married couple is filing together, the exemptions will be double. And the amounts are subject to change.

* Other high-value assets that do not qualify for exemption are turned over to the court trustee, who may then sell these assets at public auction and divide up the proceeds among your creditors.

* You are still responsible for certain debts and obligations: student loans, overdue taxes, alimony, child support, and fraudulent loans. (A loan is considered fraudulent if you slightly exaggerated your income on the application or took any steps to hide a bad credit record.) These debts and obligations are still yours to pay even after the bankruptcy is final.

Chapter 13, a more limited form of bankruptcy also known as reorganization, allows you to keep all of your property while you repay your bills. It is similar in many ways to the process of working with a credit counseling service, only the court provides you with full legal protection from your creditors. You qualify for Chapter 13 bankruptcy by showing that you are employed and have enough income to pay reduced living expenses and repay your debts over time.

* If your petition is accepted, you submit a detailed budget to the court.

* The court reviews your budget, revises it, and turns it into a monthly debt payment plan.

* You are ordered to make debt payments directly to the court, and the court pays your creditors.

* If you fall behind in your payments to the court, you will be found in contempt of court and your case dismissed. You’ll no longer be protected from your creditors. If you have no other options, you might then file for Chapter 7 bankruptcy (under which your non-exempt assets are turned over to the court and sold, with the proceeds going to your creditors).