Bankruptcy is a drastic and potent means of getting out from under an impossible burden of debt. The term covers several different procedures, but what they all have in common is having some or all of your debts "discharged" -- that is, wiped out -- by order of a special federal court.

Bankruptcy is available to both individuals and corporations, for both business-related debts and consumer debts. Most consumers file a Chapter 7 or "liquidation" bankruptcy. The theory here is that all your debts and your property are thrown into a big pot. The property is sold and the proceeds distributed to creditors in proportion to the amount you owe each, and the remainder of your debt is discharged.

In practice, however, most of the property owned by people of modest means -- personal items, home appliances and furnishings, a car, pension and insurance benefits -- is not thrown into the pot because the debtor is allowed to "exempt" them from the claims of creditors. When property is exempt, you do not have to give it up when you file for bankruptcy.

If you own your home and have owned it for long enough that the mortgage balance is much less than the home's value, you may find that the tradeoff for exempting your home is that other property, such as a car, cannot be exempted, so you must either give it up or buy it back from the bankruptcy trustee with money earned after filing your case.

Sometimes not all the debts can be thrown into the pot either. The most common examples of debts you cannot discharge are child support and divorce-related obligations, some taxes and fines, most student loans, and debts resulting from fraud. Even after going through bankruptcy, you remain liable for these kinds of obligations.

Also, if a debt is secured by a mortgage or lien on property, and you want to keep the property, you generally must keep paying under the existing contract or promptly pay what the property is worth (which may, however, be much less than what you owe on it).

In contrast, a Chapter 13 bankruptcy is more like a business reorganization. It requires you to pay off a portion of your debts over three to five years, under the terms of a plan that you propose and the court approves, and then the balance is discharged. You must have enough steady income to make these payments on top of your ongoing living expenses, and you must devote all your income, beyond necessary living expenses, to paying off a portion of your debts.

You might wonder why anyone would choose to file under Chapter 13 rather than Chapter 7. The most common situation is where you have fallen behind on a home mortgage or other large secured debt and need time to catch up in payments. You can do this in a Chapter 13 plan, but not under Chapter 7. However, under some changes in law passed in 2005, some people with above-average income are also forced to file under Chapter 13 on the general principle that they should be able to pay something toward the accumulated debt.

Any bankruptcy is a matter of public record and can be carried on the records of credit bureaus for ten years. However, it is unlikely to become common knowledge in your community.

One of the most important aspects of bankruptcy is that as soon as the papers are filed in court, creditors are automatically forbidden from taking any action to collect a debt. This means that dunning calls cease, lawsuits and repossessions cannot go forward as scheduled, and even foreclosure on a home is deferred and may be prevented. Utility service that has been terminated for nonpayment must be restored, and government agencies are not allowed to discriminate against anyone for filing bankruptcy.

The founders of this nation recognized the importance of allowing people a means of getting out from under impossible burdens of debt and getting a “fresh start.” In fact, making bankruptcy laws is listed among the powers and duties of Congress in the U.S. Constitution.

The filing fee for bankruptcy is about $300. Additional fees are charged for mandatory consumer credit counseling before filing and financial management education after filing your case. Adding the lawyer's fees, you can see how people can be in the ironic position of not being able to afford to file bankruptcy.