I have setup my editor as follows but on switching design html it changes the paths to http://localhost/ 

   <telerik:RadEditor ID="txtcontent" EditModes="Design, Html"     OnClientInit="OnClientInitFilter"
                ContentFilters="FixUlBoldItalic, FixEnclosingP, IECleanAnchors, MozEmStrong, ConvertFontToSpan, ConvertToXhtml, IndentHTMLContent, EncodeScripts, OptimizeSpans, ConvertCharactersToEntities" 
                                    ToolsFile="~/Account/ToolsFile.xml"  Runat="server"  >
                        <CssFiles >
                        <telerik:EditorCssFile Value="EditorContentArea.css" />
                        </CssFiles>
                                   <ImageManager ViewPaths="~/Img" UploadPaths="~/Img" DeletePaths="~/Img" /> 
                       
                        </telerik:RadEditor>
                  

latest demo version of controls is being used.

Hello David,

You should not experience this behavior except if the MakeUrlsAbsolute content filter is enabled.

You can see my test in the following video: http://screencast.com/t/rHsgZNqMVK9.

Best regards,
Rumen
the Telerik team