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Greek Islands with Young Children

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My wife and I are coming up on a big anniversary August 19. We've always wanted to visit the Greek islands and are strongly considering it. However, we have two young children, a boy aged 5 and a girl aged 7. We'll have about a week, maybe 10 days. We'll be flying to and from New York City.

Ideally, we'd be very happy in a small town or village with little traffic and a large beach, so the kids could run around safely. I'm assuming we'll rent a car and take a few day trips to other parts of whatever island we visit, as well as into a larger town for meals. Of course, I've noticed that recommendations vary wildly as to which islands are the most family-friendly. I've read, for example, that Crete is a good choice for its variety; Naxos is less developed and touristy, but with great beaches; and that Lesvos is also still quite authentic with wonderful variety of landscape (can't get a read on whether it's kid-friendly, though). Don't think island-hopping would be such a great idea on such a short vacation with young kids, so one island is all we'll try on this trip.

I'd very much appreciate some advice on:

1. Best Greek island for young families
2. What would be the better way to go: hotel or vacation rental?
3. Auto rentals—is it better to take a ferry from Athens to an island and then rent a car there? Are there any issues with auto rentals on the islands (insurance, etc.)? What about parking in mid-August?
4. Family-friendly restaurant recommendations on the island?

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