Filing bankruptcy is a nightmare for anyone. While it is not something you might like to even think about, there might come a time when you might have to comprehend the bankruptcy laws and file one yourself. But how can you know whether filing bankruptcy is the right thing for you? Or whether you can prevent it? What exactly is bankruptcy?

For starters, bankruptcy is a federal court process to help individuals and businesses repay their debts under the protection of the bankruptcy court (Chapter 13 Bankruptcy) or get rid of their debts completely (Chapter 7 Bankruptcy). If an individual or business files for bankruptcy, the court issues a stay that prohibits creditors from taking any action to recover the debts from you without court approval.

Bankruptcies fall under to broad categories – liquidation and reorganization. US bankruptcy laws cover liquidation under Chapter 7 Bankruptcy, which allows your assets to be sold off or liquidated to pay off your debts.

The other type of bankruptcy – reorganization is more commonly referred to as Chapter 13 Bankruptcy. Under reorganization bankruptcy, a repayment proposal is worked out with the court and accordingly some debts are repaid in full, others as a percentage of the original debt while some others are signed off without repayment. A reorganization bankruptcy would usually be spread over three to five years.

But after filing for reorganization bankruptcy, it is very important you stick to the repayment plan because it is only at the end that creditors might grant you new credit. While a liquidation bankruptcy stays on your credit history for 10 years and you are denied credit during this period, a reorganization bankruptcy can be cleared off your credit history after 6 years. And depending on your repayment record, you can reestablish your credit.

Bankruptcy filing has serious consequences and bankruptcy laws don’t look easily upon individuals or businesses filing for it. The decision to file bankruptcy should not be taken easily because having your debts erased does not miraculously solve your long term financial issues. This can only be a once in a lifetime resort to get out of crushing financial burden brought on your by job loss, medical bills, or other circumstances that are out of our control.

The best way to avoid bankruptcy is to be both “penny and pound wise,” meaning practicing good money management. This includes avoiding impulse spending, not using a credit card unless you have the cash to pay it off, tearing up any special credit card offers received, devising and following a realistic budget and covering yourself adequately by insurance (medical, homeowners, auto). At the same time, you need to make sure you don’t speculate too much or fall into company with people who have questionable financial habits.