I'm going to do my best to try to convince you not to connect the USB drive to the Time Capsule.
The fact that the hard drive is failing on the Time Capsule would indicate that it is likely 5+ years old. If that is the case, the Time Capsule power supply is also due to fail soon, so it is not a good idea to try to back up to a USB drive connected to the Time Capsule.
Even if the power supply will hold up for another year or two, the USB port on the Time Capsule is an ancient slow USB 2.0 design, and the processing inside the Time Capsule will further limit speeds to less than half that of slow USB 2.0. So, backups are going to be incredibility slow, with increased chances of errors occurring during the process.
Mac OS Extended (Journaled) is the right format for the USB drive, since the Time Capsule cannot even read a drive formatted in APFS. Now, if you will be backing up any Macs running Big Sur, then the backup must occur from the Mac using APFS to a backup drive formatted in Mac OS Extended (Journaled). Gosh, I wonder what could go wrong here.
Another option is to attach the WD Red HD to my Netgear R6400 Router and do TM backups to that. Does anyone have any comments about that setup?
Worth a try if the USB port on the Netgear router will support Time Machine backups. Probably the only way to know for sure is to test it out to see if you can run a backup. Speeds will likely be very slow because the port is probably an older USB 2.0 design.
If things work, this would be a better option than using the USB port on the Time Capsule, assuming the Netgear router is less than 4-5 years old.
A third option, since don't need hourly or daily ™ backups, I could just physically attach the WD Red drive to the individual computers when I want to make a backup. I have a to admit, the simplicity of this has some appeal even though it wouldn't be fully automated.
Time Machine backups to a USB drive connected directly to a Mac are by far the fastest way to back up as well as the most reliable way to back up. If the Macs are running Big Sur, you can format the backup drive in APFS.