Tax freedom: How to save, even when borrowing: Many people are not taking advantage of tax-free investments. Sue Fieldman looks at the best of the schemes on offer

THOUSANDS of savers and borrowers are paying too much tax. Are you sure you are not one of them?

Investors are not taking advantage of tax-free investments, which could boost their income considerably. Many borrowers, however, unwittingly lose the tax relief on the interest they pay on their home loans.

Tax-efficient investment is not just for savers with large sums of money. Save As You Earn (SAYE) is a regular savings account which is offered by many building societies. You can invest as little as pounds 1 a month, with a maximum investment of pounds 20 a month.

The building societies rarely bother to publicise the account, probably because it pays such a good rate of interest which is set by the Treasury - 8.3 per cent - tax free. It is a five-year scheme, but if you keep all the money invested in the account for another two years, you get another bonus - bringing the interest rate up to 8.62 per cent.

Mike Norrie of chartered accountants Norrie Stokes and Perrett of Tunbridge Wells has another tax- free suggestion for the small saver. He believes that Friendly Society Bonds are a good idea for children. 'The maximum is pounds 18 per month each, but all growth can be accumulated tax-free over a 10-year period,' he says.

More than pounds 1bn in tax saving is wasted because taxpayers with bank or building society accounts do not take advantage of a Tax Exempt Special Savings Account (Tessa).

A Tessa is a five-year savings plan, offered by the banks and building societies, on which the interest is paid tax-free. The maximum investment over the period is pounds 9,000. A Tessa should certainly be considered by every taxpayer.

The idea of National Savings may not be a very attractive one, but it is safe. You will sleep soundly in your bed at night knowing that your asset is on the up, as well as giving you a good tax-free return.

David Rothenberg, a partner in chartered accountants Blick Rothenberg, says: 'Especially if you are a higher-rate taxpayer, it is worth taking advantage of the tax- free returns on National Savings Certificates.' The return on the National Savings Children's Bonus Bond is 7.35 per cent.

If you are prepared to take a chance on the ups and downs of the stock market, then you should consider investing in a Personal Equity Plan (PEP). With shares held in a PEP, the dividends and capital gains are tax-free. Up to pounds 6,000 a year can be invested, all of which can be in qualifying unit trusts and investment trusts, plus pounds 3,000 in a single-company PEP.

The tax perks of a PEP are very attractive, but the charges can be high. It is best to compare one with the other before buying.

Not strictly an investment, but certainly a bit of fun are Premium Bonds. If you win - and it can be as much as pounds 1m - the prize money is tax-free.

You should also not forget that contributing towards a pension is an extremely tax-efficient investment. Mr Norrie says: 'The amounts contributed will generally qualify for tax relief on earned income, and the funds grow towards your pension age in a tax-free environment.'

Borrowers can get tax relief on the interest on the first pounds 30,000 of a loan to buy their only or main home. Since 1983, mortgage interest relief has been offered at source under MIRAS. Tax relief reduces the amount you pay for your mortgage by 20 pence in the pound. However, next year it will fall to 15 pence.

The tax benefits of borrowing money on a mortgage are now becoming less attractive. Liz Cohen, tax partner with solicitors Nabarro Nathanson, says: 'Monthly mortgage payments are becoming more expensive as mortgage interest relief is being restricted. A borrower who can afford to make a lump-sum repayment of capital to reduce the size of his original borrowing will save considerably on interest payments in future years.'

For example, a borrower paying 40 per cent tax who has a loan of pounds 30,000 at a mortgage rate of 7.5 per cent, and pounds 30,000 earning 5 per cent, will save pounds 900 by repaying the loan.

But beware. If you repay all or part of your mortgage and then change your mind later and take out a fresh loan, the new loan will not qualify for tax relief. You should only repay amounts of capital you will not need in the future.

Existing borrowers must also take care if they decide to remortgage, and at the same time increase the amount of their loan.

'Mortgage interest relief under the MIRAS scheme is not available for 'mixed loans'. As a result, MIRAS would not be available for a loan which is partly to repay an existing mortgage and partly to repay a personal overdraft,' says Ms Cohen.

'To avoid any problems, the borrower should make sure there is one new loan to replace the old one (on which MIRAS is available) and a further loan to clear the overdraft.'