Part of the cost of purchasing a home with a VA guaranteed home loan is the payment of a VA loan funding fee. Some borrowers are exempt from the funding fee like veterans who receive or are eligible to receive VA compensation for a 10% or greater service-connected disability rating.
This is good news for qualified VA borrowers who are exempt from the fee, but not all veterans have their exemption status verified at the time of the loan application.
Buyers who have a disability claim pending at the time of closing will typically need to pay the funding fee, but they can seek a refund once a disability award comes in. In such instances a refund is due to the borrower, but that refund is not automatic. It's up to the veteran to contact their lender or the VA regarding a refund.
There are VA rules which govern how that refund is applied. For example, VA loan rules forbid borrowers from getting cash back on new purchase transactions, but does this rule also apply to funding fee refunds?
No, but the VA does have regulations on how the money is to be refunded based on how the funding fee was paid originally. Borrowers must get their refund back in a similar way to how it was paid.
If the borrower paid the funding fee in cash, the refund is also returned to the borrower in cash. If the veteran included the VA loan funding fee into the loan amount, VA regulations prohibit getting cash back; the refund is applied to the loan balance instead. Here's the exact wording of the VA loan rule as found in Chapter Eight of the VA Lender's Handbook:
"A refund is appropriate if:
If the veteran was overcharged, the following applies:
“A veteran who paid cash for the funding fee receives a cash refund for the amount of the overpayment.”
For situations where an eligible veteran paid the VA loan funding fee out of loan proceeds, the lender is required to apply the amount of the overpayment against the loan balance. VA loan rules require the lender to file evidence with the VA that "the refund was applied to the loan's principal balance."