How come even though I'm using a valid file format it says "Make sure the file format is allowed in the extensions list"?

What format are you using?
And what are the dimensions?

BMP and I'm not sure about the dimensions, I just used paint

Well, these are possible problems:
1) BMP is only allowed if you have a bumpmap texture.
2) The dimension is not in a 1:1 ratio (like 128x12

So, first off, if you don't have a bumpmap texture, go into paint and save the file as a .png, then try it.

If that doesn't work, make sure the file's dimensions are in a 1:1 ratio, like I said. You could check by going to the properties of the picture.

Hope I was of any help.

If you save it as a .tga, make the RLE compression is turned off.