An Overpayment Transaction creates a Credit Note against the relevant Customer / Supplier Contact.
Once you have created the Overpayment Transaction you then have the option to either allocate it to an existing invoice/bill or refund the money.

This Knowledge Article covers how you can process a refund for an Overpayment transaction

Process the Customer refund in your Internet Banking (Receivable Overpayments) or request a refund from your Supplier (Payable Overpayments)
Once the refund payment appears on the Bank Feeds screen, process the Overpayment refund
In Xero go to Contacts > All Contacts
Find the Customer / Supplier Contact you have created the incorrect Overpayment transaction
Find the Overpayment transaction and click on the arrow next to the transaction, then select View
Once you clicked on View, the Overpayment transaction will open on the screen
Go to the Make a cash refund pane
Select/Edit the following details:
- Amount > confirm the refund amount
- Date > make sure the refund date matches the date of the payment in the Bank Feeds
- Paid From > select the Bank Account the refund was processed from/to
Click on [Add Refund]