Being upside down means you owe more on your car loan that the car is worth. This is a bad situation for a car as they usually depreciate with age (unlike real estate). The difficult part is trying to trade the car in for another car, especially if the difference is extreme. Unfortunately, for most of us, a car is necessary for employment or family. The good news is that there are strategies to make the process less painful.
Walk through an example. Let's say you owe $20,000 on a car that is now only worth $10,000. This means that you are $10,000 upside-down on the car. If you decide to trade in the car, you will have to pay the $10,000 you owe on the car plus the the cost of buying the new car.
Bite the bullet and pay off the loan. This is difficult, but it's better than carrying negative equity over from your old car loan, which will only increase the monthly car payment for your new car.
Keep the vehicle until the negative equity is gone. This is by far the easiest way to get out of an upside-down car loan. However, if your car breaks down or is inoperable, this may not be an option unless you can afford to by a used car that does not require a loan. In this case, you will need to determine whether or not it is more important to pay off the existing debt or purchase an older (cheaper) car with it. Ultimately, this decision depends on your financial situation and your willingness to say no to "new car fever."
Request a cash rebate on the new car. Continuing with the same example, if you have $10,000 negative equity on your car loan, ask the dealer for a cash rebate to cover the amount. Make the purchase of the car contingent on this cash rebate. The more cash you can put down on the new car and the better your personal credit score, the more you will be able to negotiate up the amount of the rebate.
Check for rebates and incentives yourself. You can do this on most any website dedicated to auto sales. For instance, Edmunds.com has an "incentives and rebates page" (see the Resources section for a link).