So your saying I must wipe data first and then perform the factory reset? If yes how do I wipe data from the drive?
If you can access the settings for the Time Capsule using AirPort Utility now, you can do the reset first, or you can erase the drive first. It does not matter.
If you cannot access the settings using AirPort Utility, then you will need to perform the Factory Default Reset first, then erase the Time Capsule drive.
To erase the drive....
Open AirPort Utility and click Manual Setup
Click the Disks icon at the top of the window
Click the Disks tab
Click Erase
The "Quick Erase" option will only take a minute or two
Time Machine over write data when it fills up capacity of the drive?
When the drive is full, Time Machine will automatically start to delete the oldest backups first, to make room for new backups.