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I applied for ILR SET(O) on the basis of 10 years long residence having been on a student visa (Tier 4) for that period of time. I did a masters programme and started a PhD before developing health problem that kept me for that long. I did apply in November last year (2020) and did my biometrics in December. My student visa then expired on 28 February. I am due to submit my thesis and viva date has been fixed but I became bereaved and was granted a three months extension. The university requested that I inform them of my current status in order to determine if I am to continue as a full time student. I emailed them stating I applied for ILR. A day later, I got an email from the Home Office (home.office.atlas@notifications.service.gov.uk) saying I had made my application outside the immigration rules. Please I really need advise ASAP.
The email reads as follows:

Dear XXXXXXXXXXXXXXXX

Ref: XXXXXXXXXXXXXXXX

Thank you for your recent application to settle in the UK. Your application has been made using a SET(O) application form for Indefinite Leave to Remain Outside the Immigration Rules. However, we note on your application form you state you wish to apply for Indefinite Leave to Remain on the basis of ten years long residence.

Accordingly, we would like to give you the opportunity to review your application. If after you have reviewed your application you would like to submit a further application on the correct route please advise us as soon as possible.

If after you have reviewed your application, you would like to vary (change) your application to one in another category which is more appropriate, please advise us of your decision within 14 days to the following email address: LivsetAAhub@homeoffice.gov.uk with the subject title “FAO EO4 Livset 5”.
If you advise us that you have decided to vary your application, you will be required to submit an online application with all relevant fees and requirements under the category which you believe to be more suitable. Please note, the transfer of your application does not imply it will be accepted, it will still be subject to consideration under the criteria of the new route you have chosen. Only once a new valid application has been submitted with all applicable fees and requirements would a refund of any previous application fees be processed, if applicable.

If you choose not to have your Set(O) application varied or do not reply within 14 days of the date of this email, your application will then be considered as such.

If you are unclear about what your choices are, you are strongly urged to consult with an accredited Immigration Adviser for further guidance.

Yours sincerely,
EO4
LIVSET 5
on behalf of the Secretary of State

Set O is the wrong form for ilr based on 10 years long residence.

You need to apply on form Set LR.

Sounds like you applied on the wrong form and the caseworker is giving you a chance to correct that.

You should have applied on Form SET(LR), rather than SET(O).

Thank you all for your kind assistance.
I really do appreciate this.

Please I apologise for bothering again. I need further assistance and understanding, please.

What is the difference between submitting a further application on the correct route versus varying an application to one in another category which is more appropriate?

Secondly,which one applies to my situation - the submission of a further application on the correct route OR varying (changing) application to one in another category?

Finally, do I need to pay fresh application fees if my choice of action is to submit a further application on the correct route?

Thank you once again.

Submitting a further application before a decision is varying it.
I think you pay again and get a refund of the previous application.