(MONEY Magazine) – In May, I went to a Toyota dealership in Marina Del Ray to purchase a car," says soft- spoken Theresa Witt, 50, sitting at her cluttered kitchen table with a mug of coffee in hand. "They had a huge sign in the window promising a 9% finance charge. But the salesman told me he'd have to charge me 19%." She passed.

Sky-high loan rates are just one of the repercussions faced by the $49,000-a- year registered nurse, who, like 875,000 other Americans, declared personal bankruptcy in 1995. "My biggest concern about the U.S. economy is a greater use of credit and a rise in personal bankruptcies," Clinton economic adviser Laura Tyson told MONEY recently.

This year a record 1 million of us are expected to file, according to the American Bankruptcy Institute in Alexandria, Va. One reason: high levels of short-term consumer debt, such as credit-card balances. In March, payments on such debt reached an all-time high of 20.6% of the average household's after-tax monthly income. Another reason for the surge is that the federal Bankruptcy Reform Act of 1994 doubled the amount of personal property a filer can shield from creditors (the amount varies widely by state), making bankruptcy less painful than ever. Bankruptcy's adverse effects are arguably milder than ever too, and that's one key to why its appeal is no longer confined to deadbeats and dunces. For example, even recent filers can usually qualify for at least some new loans.

Still, the post-bankruptcy period can be far from pleasant, as Witt is realizing. Her descent into debt was largely the result of an estimated $50,000 in uninsured damage to her condo from the 1994 Los Angeles earthquake, an ex-husband who left her on the hook for $50,000 in back taxes, and her own inability to save. By July 1995, when her bankruptcy was final, she owed $229,900 and had only $156,900 in assets. Now Witt, who wants advice on rebuilding her finances, is not merely suffering problems getting an affordable car loan. She's also dealing with the inconvenience of paying for most things in cash and her shame when friends discover her financial problems.

Witt's upbringing left her blissfully ignorant of budgeting dilemmas. The daughter of a prosperous chemical engineer, she was born on the tropical island of Mactan in the Philippines. Tradewinds--and five full-time servants--drifted across the family's seven-bedroom home. "I was quite spoiled," the petite brunette admits.

After she graduated from the Philippines' Silliman University in 1970 with a degree in journalism, she moved to Los Angeles to live with her sister. In 1973 she met and married Robert Witt, then 32, who ran a construction business. Interested in becoming a nurse, Theresa completed a nursing program in the late 1980s. Soon after, their marriage fell apart; they divorced in 1989, when their only child, Robin, was 14. The settlement gave Witt full custody of their daughter and $400 a month in child support but no alimony, plus approximately $31,500 worth of assets. "I spent that money like water, I'm ashamed to say," Witt admits.

Then in August 1990, while working as a $42,000 administrator for Prudential HealthCare and a part-time administrator for a Veterans Administration hospital, Witt received a shocking letter from the Internal Revenue Service. It said that she and Robert owed more than $50,000 in back taxes and penalties from 1984 to 1987, mostly on the income from Robert's unincorporated business. Witt says she had no idea they were in arrears. But when a couple file jointly, as the Witts had, the IRS considers both spouses to be equally responsible for any unpaid taxes and penalties. "The penalties kept putting me further behind," explains Robert, who is still living in the Los Angeles area and who managed to pay at least $23,000 toward the tax in 1990. The next year, the IRS kept Theresa's $592 tax refund from 1990 to put toward the debt.

Despite the IRS breathing down her neck, later in 1990 Witt took the $40,000 she'd received from the sale of some family property in the Philippines, plus $2,000 left over from her divorce settlement, and used it as a down payment on a $210,000 condominium in Woodland Hills, near her Prudential job. "I thought I finally had the American dream," she says. "I was taking care of my child, I had a good job--and now, my own home."

She got a pink slip from Prudential in December 1992, eventually going to work full time at the VA for a slightly higher $44,000 a year in 1993. Still, she found that her expenses quickly eroded her $2,150 monthly take-home pay. Those expenses included her $1,000 mortgage bill, $250 condo fee, $120 utility and phone bills, $300 for groceries and $200 for entertainment--plus $100 on mother-daughter dinners out and $300 a month on indulgent shopping sprees to buy clothing for Robin. "I didn't want her to feel the pinch," Witt admits. She began to slide into debt.

Then, in January 1994, the massive Northridge earthquake rocked her condo. It couldn't have come at a worse time. A few months earlier, her condo board had voted to eliminate earthquake insurance to curb maintenance fees, and Witt lacked quake insurance of her own. Though her condo was still livable, an independent contractor's assessment noted structural damage that could cost Witt at least $50,000 to repair. Rather than pay, she pondered selling. "The worst aftershock I had was when I found out I could probably get no more than $120,000 for it as is," remembers Witt, whose mortgage balance was a much heftier $166,500.

She decided to stay put until she could figure out what to do. She was overwhelmed by what she owed: that $166,500 on her mortgage, $44,000 total to the IRS, $6,600 on eight credit cards, $4,700 in overdue condo fees, $3,100 in accumulated medical bills and $1,100 in property taxes, plus a few smaller debts. Besides the condo, she had assets valued at just $36,900 total, including $14,300 in an Individual Retirement Account and $6,600 in an employer-provided retirement savings plan (see the table on page 132). Her only cash was the $500 in her checking account. She couldn't afford to pay the $1,500 or so a month it would take just to service her debt, not to mention the back taxes and condo fees. Her parents couldn't help; her mother had died in 1980 and her father in 1993, leaving modest property that was tied up in legal proceedings.

In October 1994, a desperate Witt borrowed $4,200 at 7.1% interest from her retirement plan to cover some of her bills. That same month, she consulted Los Angeles bankruptcy attorney Ethel Selvester. "There was no way she could pay off everyone she owed and have any chance at retiring," says Selvester.

So Selvester advised Witt to declare Chapter 7 bankruptcy, which would erase all of her debts except for her retirement plan loan. (For more details on Chapters 7 and 13, see the box on page 134.) Under California's bankruptcy provisions, Witt would be allowed to keep all of her appliances, furnishings, clothing and car. Most savings and investments and some assets, including her condo, could be seized by the court to discharge her debts. But Witt had virtually no savings except her retirement accounts, which are usually protected by federal law. She would get rid of the debts she owed to her credit cards, surrendering the cards in the process. (Exception: Witt decided to pay off her $127 balance on one department store account, Robinsons-May, so she could keep it; because she had a steady job, the store considered her a tolerable risk.) Bankruptcy generally discharges back taxes that are more than three years old, so she'd also escape the IRS' clutches. "I felt like I was walking away from my responsibilities," she concedes, "but I couldn't see any other way."

The worst moment came when she had to tell Robin. "I had hidden everything from her," says Witt, who does not require Robin, now 21 and still living at home, to contribute for household expenses any of the $200 a week she earns as a waitress. Her daughter was shocked and unhappy. "It really sucks, because now we have to keep cutting back," Robin laments.

In March 1995, Selvester filed a court petition to declare bankruptcy and 10 addenda detailing what Witt owed. At Selvester's instructions, Witt stopped paying her mortgage and condo fees because filing for bankruptcy temporarily stops any foreclosures from proceeding. (Two months earlier, fearful of another quake that would make the condo even more unstable, she and Robin had moved out and into their current $950-a-month apartment. Because she hadn't filed yet, she had no trouble getting approved for a lease.)

Witt had a one-month waiting period before her dreaded April 1995 appearance before the court-appointed bankruptcy trustee. "The trustee just asked me two questions," Witt recalls. "'Do you understand what declaring Chapter 7 bankruptcy means?', and 'Is everything you said in your court papers true?' I only had to say 'Yes' twice, and we were done." Her filing fees and attorney fees, part of which she had paid in advance, had totaled $860. In July, when her bankruptcy was final, the bank repossessed her condo. Poof: Her net worth transformed from a negative $73,000 to a positive $33,400. The speed of the process left Witt in shock. "I had no idea how things would change," she says quietly.

But change they did. Because she lacked Visa or AmEx cards, she had to pay for everything--groceries, clothing, gas--in cash or by check. "Sometimes I prayed I'd make it home without running out of gas, because I didn't have a check or any cash in my pocket," she says. She longs to take a weekend trip to Mexico, but without a credit card, she can't easily make a hotel and rental-car reservation. Moreover, though she'd like to help Robin pay for the community college she plans to attend this fall (Witt already spent $1,900 on acting classes for her over the past 12 months), she has no liquid savings to enable her to do so.

The personal fallout has been just as hard to take. So far, Witt has confided in only a handful of close friends and family members about her bankruptcy. "So many people would think I'm a lousy person," she says. "When I told one co-worker, she bitterly told me about someone she knew who declared bankruptcy but still drives a fancy car."

Witt is taking some steps to rebuild her sullied credit record. For example, in August 1995 she obtained a debit card that removes money directly from her checking account. She can use it to buy goods from several area merchants. And she makes small purchases with her Robinsons-May card that she usually pays in full right away to show that she can handle debt responsibly.

Witt has also begun to worry about saving enough for her retirement. She's put only 20% of her retirement money in stocks and the rest in safe but low-yielding bonds. "I'm worried about losing it all, and I keep thinking I'll retire to some tropical island where it's cheap to live," she says.

THE ADVICE:

Financial planners Delia Fernandez of Long Beach, Calif. and Margie Mullen of Mullen Advisory in Los Angeles gave Witt these recommendations:

--Get a secured Visa or MasterCard. Secured cardholders keep some cash in a interest-bearing account as collateral; their credit line is usually limited to that amount. Fees are steep: an average $35 to apply, $35 annually to maintain the account and a rate of as much as 22% on balances. After using this card responsibly for about three years, Witt will probably qualify for a regular card.

--Ask your bank about a car loan. Because Witt has a solid record using her debit card, Mullen says she has a good chance of convincing the issuing bank to grant her a car loan at a rate that could be five percentage points lower than the 19% she was quoted at the dealership.

--Monitor your credit report. As Witt works on rehabilitating her credit, she should check out her credit report every year to make sure the good habits she has developed are being duly recorded. She can get one report free every year from the big credit bureau TRW (800-392-1122).

--Build an emergency fund. Fernandez suggests that Witt immediately begin putting at least $200 a month into Dreyfus California Tax-Exempt Money Market (recent yield: 2.8%; 800-645-6561), with the goal of building an emergency fund equal to at least three months' worth of expenses. Mullen notes that she can easily pare her budget by $400 a month if she cuts her entertainment, restaurant and clothing bills and asks Robin to contribute $200 a month to the rent.

--Get real about retirement savings. Witt needs to start saving as much as she possibly can for retirement--certainly no less than a doable $300 a month outside her company plan. Even so, because she's off to a late start, she probably won't be able to afford to retire until she's nearly 70, figures Mullen. She should put most of her retirement money into stock mutual funds such as Janus (up 16.6% for the 12 months to Sept. 1; 800-525-8983).

Witt has not yet upped her saving. "I've decided to put extra money into going to school part time for my master's in nursing," she says. "That should help me increase my salary in the future."