Midnightmike, I'm not sure what exactly it is that you are asking, so here are my thoughts on the subject.. If you can do it with an internal hard drive, you should be able to do it with an exteranal hard drive. I, myself prefer to use my external, since it comes with a terabyte of space. You should be able to tell your decrypter to decrypt to "E:\whatever" (assuming "E" is your drive letter), instead of "C:\whatever". It should work the same.
Also, about layer breaks, if you rip the individual files to you hard drive (.ifo ,.bup, .vob) you shouldn't have to worry about layer breakes. If you rip a disk image instead (.iso, *.bin, ect.) your ripper program should include that information when creating the image.