There's even a line about Rachel's hair in one of the later episodes that season (where Joey bids on a sailboat he can't afford at a charity auction). Phoebe asks Rachel what's going on with her hair. Rachel asks if something is wrong with it, and Phoebe says, no, I like it in kind of a sexy way, like she wants Rachel to cover her naked body with it. Or maybe that's just my dirty mind at work!

Given that Rachel came back the next season with pretty much a bob cut, it makes sense that the extensions ruined her hair so she just chopped it off.