As far as I can tell, when guitarists want to play short, semi-muted notes, they usually use palm muting with the picking hand. However, you can get a similar sound by fretting the notes with your finger on top of the fret instead of behind it. Is there a reason why this muting technique doesn't seem to be used much, besides the obvious drawbacks that it doesn't work on open strings, and you can't quickly switch between muted and unmuted notes? Does any well-known musician use this technique more than sporadically?
The technique you describe is called étouffée. It is indeed less frequently used. I would say the main reason is that you can mute strings stronger with palm muting, which produces a more distinct effect. Also placing fingers on top of the frets requires some more precision in the fretting hand. However, if you find an application for this technique, go ahead and use it, there is nothing wrong with it!