If she is interested in you romantically, you can not make her your friend without hurting her.
You did not specify how well you know one another, but I am guessing not that well. Then it is not that bad, as it is unlikely that she is truly in love with you or something like that.
Honesty without being rude is the way to go.
Try to be honest and direct about how you did not feel a spark to fire up a relationship, but you did like her and would want to spend time with her. This will, of course, hurt her a little if she wanted your relationship to go further than just friendship.
The important part is not talking around it and make it sound like a "maybe", but to be direct. If you give her hope that you are going to crush later, you are being cruel. It is important not to give false hope.
There are two basic ways this can go down:
- She is hurt and does not want to spend time with you - If that is her reaction when you are honest and friendly, it was unavoidable that her feelings got hurt.
- She is a little hurt, but likes you enough to want to meet you in the future again.
@JackAidley pointed out, that there are two more options I completely forgot about:
- She feels the same way and is glad of the outcome
- She's actually just not interested
In those options her feelings are not hurt, though.
Option 4 would then only potentially hurtful to you, depending on your stance on things.
You need to steer clear of mentioning her appearance
If she is likely to be insecure about her appearance, do not mention it at all. If she wants you to elaborate on why you do not want to be with her, talk about how you think your personalities are not compatible for that. But it would be best to avoid that, too.
Make it clear that you like her and would like to spend time with her.
A personal note:
I would recommend not to start anything sexual in a situation like this, if she agrees to being friends. I she suffers from loneliness, too, as you said, then it could help her, but it could also turn into a dependency thing or an almost-relationship (which would be similar to giving false hope).
The only way I see something sexual being okay is if there is in-depth communication about what both of you want from the relationship and find an agreement. That is the best way to prevent hurt feelings on both sides.