In some cases, an individual (the debtor) has accumulated principal and interest to such unmanageable levels that there is no realistic possibility of ever paying it off. In these instances, filing for bankruptcy may be the best course of action. While the U.S. Bankruptcy Code is complex, the various chapters have a basic theme in common: bankruptcy generally allows certain kinds of debts to be “discharged,” thereby allowing the individual or business debtor a chance reclaim control of his finances, and with time re-establish his credit score. Bankruptcy procedures vary greatly, depending on the identity of the debtor and the types of debts. A major theme of the Bankruptcy Code is the difference between “secured” and “unsecured” debt. Secured debt is a loan backed by collateral, such as real or personal property. If a debtor defaults on a secured loan, the lender often will be able to reclaim or force a sale of the collateral and use the proceeds to satisfy all or a portion of the debt. A mortgage on a house or a car loan are typical examples of secured debt. Unsecured debt, on the other hand, is a loan which is backed only by a promise (or contract) to repay. Unsecured debt generally poses a greater risk for a lender. The types of recourse available to the lender if the debtor fails to meet his obligations under the account are more limited. Unsecured debt is particularly problematic for the lender should the debtor file for bankruptcy, as unsecured debts are often discharged depending on the order in which they were created (their priority). A consumer credit card is a classic example of unsecured debt.

Another central theme of bankruptcy is the concept of “equity,” or how much ownership interest a debtor has in certain property. For example, if you took out a mortgage for $200,000, have paid $100,000 off, and the current market value of the home is still $200,000, you as the debtor have $100,000 of equity in your home. Equity is a crucial concept in bankruptcy, as the amount of equity a debtor has in a given asset can sometimes dictate whether that asset will be liquidated- sold or auctioned off- to satisfy creditors’ claims.

Exploring bankruptcy as an option usually involves careful scrutiny of the whole financial situation: including the debtor’s assets and liabilities, types and current market values of collateral securing the debt, income and expenses, and what is sought to be accomplished through bankruptcy (i.e., total discharge or a repayment/debt restructuring plan). In most bankruptcy cases, the procedure is coordinated and overseen by a Trustee in Bankruptcy. The trustee is appointed by the U.S. Department of Justice as a neutral arbiter to ensure that all procedures are followed to the letter and spirit of the law, and that the creditors and the debtor are treated fairly. Only after careful consultation with your attorney will you be able to decide which option is right for you, and this handout is provided only as a very basic primer. You should always meet with a licensed attorney or other qualified professional in considering which legal options are right for you.