Can an employee have their loan payment taken out of their payroll directly instead of having an AFT from the checking to the loan? Is their any reason we should not set it up this way?

It would be a purely a contract between the employer and the employee. I would think that it might have to be voluntary however.

This would have to be voluntary due to restrictions under Reg E re compulsory use (1005.10(e)) and the choice must be revocable.

I'm not sure that Regulation E would apply to a direct payroll deduction, as the deduction would happen prior to the money ever making it to the consumer's asset account.

I think this would actually be covered under State employment laws. I checked a couple of States and it appears legal if supported by a written agreement between the employer and employee. There are caveats, such that the debt cannot be accelerated and the remaining balance of the loan cannot be withheld from the final paycheck in the case of termination in California.

True....it is payroll, not checking. I have worked at banks where we did this, but only by agreement. I would think most states will have a similar restriction as a consumer protection. It is the same concept.