Not sure if those are the proper terms, but I was debating which would be the best approach ... mentally I split the sandbox game world into 'Overworld' 'Standard Interiors' and 'Underworld Interiors'

The overworld being the "world" as a whole, much like on many TES games one large map to explore.

The standard interiors would be things like the inside of houses, shops, etc, while underworld interiors are things like caves, dungeons, evil fortresses, etc ... would having these be generated or made within a separate instance be more advantageous than having seamless access (As in there is no load screen for entering one of them, you just open the door into a house, walk into the cave and its there ... part of the overworld maps "instance" as a whole?)

Not sure if those are the proper terms, but I was debating which would be the best approach ... mentally I split the sandbox game world into 'Overworld' 'Standard Interiors' and 'Underworld Interiors'

The overworld being the "world" as a whole, much like on many TES games one large map to explore.

The standard interiors would be things like the inside of houses, shops, etc, while underworld interiors are things like caves, dungeons, evil fortresses, etc ... would having these be generated or made within a separate instance be more advantageous than having seamless access (As in there is no load screen for entering one of them, you just open the door into a house, walk into the cave and its there ... part of the overworld maps "instance" as a whole?)

It all depends on what type of game I am trying to put forth.

Will there be structured play or do you want a world that is open for the player to do as they wish without any specific goal established for them?

It all depends on what type of game I am trying to put forth.

Will there be structured play or do you want a world that is open for the player to do as they wish without any specific goal established for them?

Its all very much conceptual at this stage, but the latter ... the player is able to generate a new world with their game (such as in the vain of Minecraft) and it will be populated with villages, towns, cities of varying cultures/races (These will be pre-defined I think, but will appear on the world differently each time its generated). The idea of goals follows a similar line: NPC A is generated as a Quest Giver, the Quest is than generated through a combination of elements (Kill/Rescue/Impersonate -> Wizard/Princess/Ogre) ... which does make me wonder how difficult it would be to assign the quest to an actual location, a predefined dungeon, or with each quest an "Entry Way" is generated on the map that leads to an instance of the 'dungeon'.

Sounds like a seamless world would be better suited to your situation. Anything that has a large amount of detail in it will most likely need to be defined. You could zone off specific areas (like dungeons) in a similar way to provide a more controlled experience when needed.

As for the quests I swear it has been done before (maybe daggerfall?) but I have no idea if it is easily done or not. Quests will lose some of their impact if they're randomly generated thought. I can imagine there's a way to get over that while still keeping it generated on the fly, I can't imagine that being very easy though.

I am trying to determine the best way to create a UO-esque 3d world that if you sail far north you will eventually reach the southern edge of the world, no artificial boundaries. Rather than going full 3d with a free pan camera I wanted to work with a fixed camera with 3d assets. The world would still need to have zones, seamless as possible, but I have a hard time picturing how best to do so. I am guessing it will be like building a puzzle where each edge of a piece will have to be linked to the adjacent pieces to build the world complete.

Good news: All I really need to get the world started with is an island. Large enough to explore, but it is aimed to be more a starting area where the world "begins". Players at the start of play will have to discover things and work towards getting off the island, mainly joint creation of a boat. Once these "settlers" board the boat they can set sail to try and return to the primary portion of the world. There will be moments in the game where names are recorded for future players to encounter and see what deeds they accomplished. The players will find that most of the mainland is very uninhabitable and they need to find pockets of survivors to establish themselves and work to reclaim the world. Fantasy MMORPG. Securing areas of the world that were once important areas of the world may unlock certain portions of the game for players to progress with, new races, skills, cities, conflicts, etc.

Couldn't find a good video, but there are certain ways to make buidings that does not cope well with using loading zones when entering interiors.
My example is the monastery in the game Risen.
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It's got a fort like structure, with narrow passages, and with rooms on the sides. These are usually very small rooms, and putting a loading zone on this wouldn't make sense. You also wouldn't get the same light effects based on time of day (especially rising or setting sun). You could put these smaller rooms in some indoor corridor, but I don't think that would be as atmospheric.
What you see in Skyrim is loading zones for each house, but they are large and few instead. In a realistic medieval town you would see lots of very small houses along narrow streets.
Visiting the many "cities" in Skyrim was disappointing.

The harbor town of Khorinis in Gothic 2 is another example, and (in my opnion) the most immersive town in a game. Graphics are somewhat dated now though.
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Both the monastery and harbor town did have a quite noticeable higher hardware demand though.
Putting a loading zone on such very small interiors (and you get lots of them), would lead to a quite annoying frequency of loading screens.
Not filling a town with many smaller houses (especially in making poorer areas) can ruin immersion
In Risen/Gothic 2 there are no such loading zones. In Oblivion, every interior is a zone. It should be possible to use loading zones, but also have houses without a loading zone.
So that some special buildings and or large houses may be in a separate zone, but most (preferably) is not.
Ofcourse my idea of a quite large and dense town wihere you can enter all interiors and no (or few) loading zones will not be hardware friendly, yet settling with the less demanding solutions might not make towns as lively/atmoshperic.

Couldn't find very good videos.

The harbor town of Khorinis in Gothic 2 is another example, and (in my opnion) the most immersive town in a game. Graphics are somewhat dated now though.

I may have to pick up Gothic 2 and have a first hand look, its highly spoken of on its own merits at any rate. I think one issue is if a house is filled with interactive objects (if every bowl and spoon is able to be picked up sort of thing) and of course the major attraction of playing a thief route is to break in places and steal valuables.

I guess I am going to spend some of my free time playing with Unity to create pieces of terrain to see if I can get a "starter" island developed. Small village, a dock or two, must have a small inn, and then populate it with trees/resources for players to interact with. There will be a small amount of combat available, to get started on being a fighter, but not many will truly be monsters/etc yet, peaceful island. I am not really sure how each piece of terrain would be linked, nor the size I should make them, but practice can't hurt, eh? Art assets and MMO capacity be damned, maybe it will lead to something.

*Edit* Perhaps instead of Unity I should look into this HeroCloud thing.

I may have to pick up Gothic 2 and have a first hand look, its highly spoken of on its own merits at any rate. I think one issue is if a house is filled with interactive objects (if every bowl and spoon is able to be picked up sort of thing) and of course the major attraction of playing a thief route is to break in places and steal valuables.

It's possible to hybridize. Larger rich man's houses or some special buildings could be a zone, and therefore have lots of items within. The many poor man's houses doesn't necessarily need that many items, and also the number of different types should be reduced (no silver spoon in slum houses). It's also possible to make a town a separate zone, and maybe split up areas of a town. It should feel fairly consistent though, and zones should have a natural barrier.