First I tried printing directly onto fabric stuck to freezer paper. Did not work. My second attempt was with t-shirt transfer paper. That actually worked quite well, but the labels won't look as nice as you'd probably want them to. Also, t-shirt transfer paper is too expensive for a cheapskate like me. I then read a few places about people using spoonflower.com to create their own labels.
At http://www.spoonflower.com/ you can upload your own design and have it printed on fabric, wrapping paper or wallpaper.Would make sense that you could have your own labels printed that way as well, so I decided to give it a shot.
You'll need to make sure your label design is the size you want it to be, plus a few extra inches of empty space around it. I made mine using photoshop, but any photo editing software should do the trick.
Upload your design to spoonflower, and make sure you choose basic repeat. You can then chose the type of fabric you want and the amount(a fat quarter gave me 150 labels!)
Once if arrives, prewash your fabric and iron your fabric before cutting.
Cut your fabric, making sure you leave enough space to fold the edges down with an iron.
Either sew the edges down right away or leave them like they are until you are ready to sew them onto a garment.