I think OPs issue is that he has signed a 24 month contract, upgrading from simplicity, to get a free Xperia handset of some kind.
The phone appears to have developed a fault after only two months into the contract. He has contacted O2 and they have told him to take it into a store and book it in for repair. At the same time they have offered him a loan phone at a cost of £25.
elaine - The person you spoke to is only following procedure. If you have a faulty handset O2 practice is to send the phone for repair and that process is done through the store. As far as I am aware they are under no obligation to lend you a phone, it is just best efforts. At £25 you could probably buy a PAYG phone and put your SIM in it.
Having said that, I think it is a little harsh to put you through that after only two months but that is only my opinion. If you want to make a complaint look here
http://tiny.cc/vr9f5