Some 152,000 former customers of defunct bank Northern Rock are to receive an average of £1,775 in compensation following a paperwork error.
Northern Rock Asset Management (NRAM), the state-owned remnant of Northern Rock, will pay out £270 million in refunded interest after the bank failed to make mandatory disclosures in customer letters since 2008.
UK Asset Revolution, NRAM's holding company, will contact potentially affected customers in writing with further information in the next few days.
The refund is likely to increase public sector net borrowing for 2012/2013, Treasury economic secretary Sajid Javid said in a statement to Parliament.
However, the refunds are "not expected to delay materially" the timing of NRAM's repayment of £19.6 billion of Government funding.
Speaking at Treasury questions, Chancellor George Osborne said customers who had loans below £25,000 were affected and blamed "an error originating in 2008 when Northern Rock was in public ownership".
He told the Commons: "Some customers with certain types of mainly unsecured personal loans were not given all the mandatory information in their statements which they were entitled to by law. As a result, interest payments on these loans are not legally enforceable."
UK Asset Revolution (UKAR) identified certain loans where the documentation was not compliant with Consumer Credit Act (CCA) requirements.
UKAR chief executive Richard Banks said: "NRAM is acting in accordance with its legal responsibilities and we are determined to do the right thing for customers and the taxpayer.
"We will be writing to all customers who are affected and advising them on next steps. We have not received any complaints or claims as a result of this matter and as far as we are aware, it has not resulted in financial loss for customers."