We are not aware of any law that would prohibit you from refunding a loan payment after it has been applied, although doing so in this situation conceivably could violate a term of your loan agreement and infringe on your borrower's rights and expectations.

If you do decide to refund a portion of the relative’s loan payments, first you should review your loan agreement to determine whether refunding the payment after it has been applied could be construed to violate any of its terms. There probably is a good argument that it does. Negating this payment after it has been received and applied could become the basis of a default, now or in the future, if your customer does not quickly make up the difference. We think you should contact your customer and inquire whether he will approve the refund and cover the difference, and if not, we would recommend declining the refund request.

Obviously, it would be preferable to avoid becoming involved in a dispute between two family members, but this may be unavoidable no matter which decision you make in this case.